Despite reporting better-than-expected fiscal second-quarter results and raising its full-year guidance in early September, Slack Technologies (NYSE:WORK) stock plunged by 14% the following day. And in less than two weeks, the company's valuation had dropped by more than 20% this month. Here are three reasons for such a steep drop.

1. High expectations

By Sept. 1, Slack's share price had increased 90% from its March lows to $34.30, bringing the company's enterprise value-to-sales ratio to 26.5. That lofty valuation indicated the market hoped for a spectacular increase in the use of the Slack's cloud-based communications platform despite the broad economic uncertainty.

Less-than-stellar fiscal second-quarter results, while still above management's guidance, failed to support the company's stock price. 

Metric Guidance Fiscal Q2 Results
Revenue $206 million to $209 million $215.9 million
Adjusted operating loss ($18 million) to ($22 million) ($6.7 million)
Adjusted EPS ($0.03) to ($0.04) $0.0

Data source: Slack Technologies. EPS = Earnings per Share.

The early success of the company's new feature, Slack Connect, which allows enterprises to communicate by securely sharing Slack channels, explains a part of the better-than-expected performance. That feature reinforces and expands Slack's network effect beyond the traditional enterprise boundaries.

Slack app on a Mac

Image source: Slack.

The number of customers using Slack Connect increased 160% year over year to more than 52,000. And CEO Stewart Butterfield indicated during the earnings call that in just six weeks, Slack Connect helped attract more than 1,000 out of 8,000 new paid customers in Q2. As a result, the company now has a total of 130,000 paid customers, up 30% year over year.

Given these strong second-quarter results, management raised its full-year guidance.

Metric Previous Fiscal Full-Year Guidance Updated Fiscal Full-Year Guidance
Revenue $855 million to $870 million $870 million to $876 million
Adjusted operating loss ($100 million) to ($110 million) ($70 million) to ($75 million)
Adjusted EPS ($0.17) to ($0.19)  ($0.13) to ($0.14)

Data source: Slack Technologies.

2. Relative underperformance

That raised outlook remains modest compared to the recent stellar performance of some other tech stocks, though. In particular, video calling specialist Zoom Video Communications smashed analysts' expectations and management's guidance during its last quarter as existing and new customers led to 355% year-over-year revenue growth.

In contrast, Slack hasn't profited as much from the boost in remote communications in Q2 as it faced challenges with its installed base. Its dollar net retention rate dropped to 125% compared to 136% one year ago, which means revenue growth from existing customers decelerated to 25%.

During the earnings call, management justified that relatively disappointing performance by attributing it to the downsizing of smaller customers because of the economic uncertainties. In addition, management said, larger enterprise customers prioritized other short-term solutions.

Against a backdrop of stay-at-home orders, which should boost the demand for remote communications, it seems Slack's platform doesn't wasn't in as high demand as solutions such as Zoom's products, for instance.

3. Tech industry sell-off

Beyond Slack's own challenges, tech stocks seem to be facing a broader sell-off after a market rally partly driven by the trading activities of the conglomerate SoftBank Group, according to the Financial Times. On Sept. 8, the Nasdaq Composite entered into correction territory as it dropped 10% from its previous highs on Sept. 2.

It's impossible to predict how these market reactions will evolve, but Slack's high valuation in the volatile tech sector certainly contributed to the plunge of its stock price in September, independently of the performance of its business.

Looking forward

In any case, second-quarter results disappointed investors as shelter-in-place orders didn't benefit Slack as much as hoped.

Yet even with the improved guidance and the lower stock price, the company's valuation remains elevated at an enterprise value that represents 18 times the midpoint of the anticipated full-year revenue range.

Investors should pay close attention to the company's announcements at its Slack Frontiers user conference on Oct. 7 and 8. New products and features, especially related to Slack Connect, may improve Slack's platform attractiveness to justify that valuation.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.