Shares of content delivery network provider Fastly (NYSE:FSLY) have been getting hammered ever since the company cut its guidance in October due to lower revenue from its largest customer TikTok and lower usage from some of its other customers. The stock has been trending downward ever since that announcement, and its third-quarter earnings report did nothing to stem the tide.

Fastly stock has now been cut in half since peaking prior to the guidance cut. Revenue grew by 42% in the third quarter, which is great in a vacuum. But relative to Fastly's extreme valuation before the guidance cut, it wasn't nearly enough.

For those thinking about "buying the dip," think again. Fastly's revenue growth is set to slow dramatically despite a worsening pandemic ostensibly providing benefits to cloud-based companies. The premise on which Fastly rallied this year no longer appears sound.

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Hard to justify

Fastly expects to produce between $80 million and $84 million of revenue in its fourth quarter. At the midpoint of that range, revenue will grow by 39% from the fourth quarter of last year. However, this guidance includes an expected $8 million contribution from the acquisition of Signal Sciences. Backing that out, organic revenue is expected to grow by about 25%.

Revenue growth of 25% sounds great, but it's not great for a high-flying cloud company that trades at a ludicrous valuation. At its peak, Fastly stock was trading hands around 50 times trailing sales. That multiple has dropped to roughly 23 after the brutal sell-off. Fastly still isn't profitable even on an adjusted basis, so there is no price-to-earnings ratio.

You may be thinking: Paying 23 times sales for a 25% grower doesn't sound that bad. But if Fastly's growth is slowing down so much now, there's little reason to assume that 25% growth is necessarily sustainable.

There's also the problem of comparison. CDN giant Akamai grew revenue by nearly 12% in its third quarter, and it trades for right around 5 times sales. Akamai is also profitable, and trades for less than 30 times earnings.

Fastly now expects to grow about twice as fast as Akamai excluding acquisitions from a much smaller revenue base while producing losses, and the stock still commands a price-to-sales ratio nearly five times as high. That just doesn't make much sense.

An undeserved SaaS valuation

Many software-as-a-service companies trade at lofty valuations partly because they enjoy extremely high gross margins. It costs little to delivery each new unit of subscription software, so seeing gross margins approaching 80% is the norm.

But Fastly doesn't have the same economics. The company's cost of revenue includes fees paid for bandwidth, peering, and colocation. Fastly has arrangements with network service providers for bandwidth, and it said in its annual report earlier this year that its cost of revenue may increase as a percentage of revenue as it grows. In the third quarter, Fastly's gross margin was just 58.5%.

Profits can grow very quickly for a SaaS company as it scales because of that high gross margin. For example, video conferencing company Zoom went from reporting just $5 million in net income for the third quarter of 2019 to $186 million for the third quarter of 2020 thanks to a pandemic-driven sales bonanza. That kind of thing isn't going to happen for Fastly.

With slowing growth and a still-crazy valuation, don't be tempted by Fastly stock as it continues its descent. At some price, Fastly will offer a solid risk-reward trade-off for investors. But it is not this price.

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.