Is Okta Stock a Buy?

Okta (OKTA -0.89%) stock has returned an amazing 1,300% for those who have owned it since the company went public a little over three years ago. Even amid the pandemic, the stock is setting fresh all-time highs in 2020 and leaving sidelined investors wondering if they've missed out on the opportunity presented by this cloud-based identity management specialist. But that may not be the case.

Okta stock price from April 7, 2017, through Oct. 15, 2020. Data by YCharts.

The business of identity management

Providing robust security for your network infrastructure while still making it easy for authorized users to access the tools they need is difficult, but Okta does just that. It was founded in 2009 to provide a cloud-based workforce identity service that offered employees access to a dashboard of all the software they use with a single sign-on. At the same time, the service gives information technology teams the ability to manage access across their enterprise tools. The result was a compelling offering that has enabled the company to grow into a business with over $700 million in trailing 12-month revenue.

Looking at the most recent five quarters of results gives you an idea of the solid growth Okta has experienced. Highlights include consistent 40%-plus revenue growth, hundreds of customer additions every quarter, high growth of its remaining performance obligations (value of all contracts not yet billed), and solid rates of net dollar retention.

Data source: Company earnings presentation. Dollar figures in millions. YOY = year-over-year. FY = fiscal year.

All of these impressive figures are driven by a massive market opportunity. 

A number of ways to grow

Okta's primary source of revenue is its workforce identity tools to manage authorized user access to internal applications, but the company also utilizes that infrastructure to facilitate identity management for customers. The customer identity management segment is growing at a 70%-plus year-over-year growth rate and makes up about 24% of annual contract values. Annualizing the most recent quarter's revenue puts the customer identity segment at close to a $200 million run-rate business.

Data source: Company earnings reports and earnings conference calls.

But both of its products still only account for a tiny portion of the incredible $55 billion total addressable market.

Management is driving growth in a number of ways. First, it's growing its customer base by attracting them with its flagship single-sign-on offering that gets Okta's foot inside the customer's information technology infrastructure. Once its product is embedded into the identity management process, customers naturally expand their footprint into other products, as evidenced by the strong and consistent net dollar retention rates.

The sales team is particularly focused on large customer accounts, especially the largest Global 2000 customers. Its international revenue makes up only 16% of the overall business and can be a huge driver of growth over the coming years. 

Lastly, as customers bolster their workforce security, Okta can also help them better manage customer security with its customer identity management platform.

The growth runway for this cloud company is tremendous, but that opportunity comes at a price.

Image source: Getty Images.

The stock isn't cheap

There's no doubt that Okta carries a lofty valuation. The company still isn't posting profits, so investors have to rely on metrics like the price-to-sales (P/S) ratio. Okta trades at 44 times trailing 12-month revenue as of this writing, far above the 2.5 average for the S&P 500. That multiple certainly has some investors saying, "It's absurdly overvalued." I'll take the other side of that argument.

In a recent interview, Chief Operating Officer Frederic Kerrest shared some details that indicate cloud adoption is still in its very early innings. He stated that cloud-based tools only account for about $115 billion in annual spending, a small portion of the $3.8 trillion spent each year on information technology. As cloud-based tools become more prevalent, Okta's platform becomes an even more important piece of managing an organization's network infrastructure.

The company is well-positioned to take advantage of the tremendous growth in cloud applications in the coming years. First, its platform is incredibly sticky. Once organizations start to adopts its products, it becomes embedded into the enterprise infrastructure, making it hard to switch out. Second, Okta has a solid pipeline of new customer prospects. Its recent Oktane customer conference, which had triple the normal attendance because it was virtual, has given the sales teams plenty of solid leads for future quarters.

Lastly, its revenue growth has been impressively resilient to the coronavirus and pullbacks in information technology spending. Posting 43% year-over-year growth for the most recent quarter and projecting full-year gains of 37% is certainly a strong result in a volatile and uncertain economy. As the coronavirus winds down, growth could accelerate even further. 

Is Okta stock a buy?

For me, this quality tech stock is worth its premium price and is a buy for patient shareholders. It's still in the early innings of the worldwide shift to the cloud and is well-positioned to benefit from this long-term trend. If you're interested in buying shares but remain hesitant due to the lofty valuation, you might consider buying in thirds. That way, you can ease into your position over time and take advantage of any pullbacks in the share price.