What happened

Shares of Okta (NASDAQ:OKTA) were slipping for the second straight day following its fourth-quarter earnings report Wednesday night. The results included bottom-line guidance for fiscal 2022 that was well below the analyst consensus, and it also announced a $6.5 billion all-stock acquisition of identity-access peer Auth0 that seemed overpriced to some investors. 

That report also came at a time when investors are rotating out of high-priced growth stocks like Okta and into more cyclical opportunities as interest rates rise, pressuring valuations.

As of 12:03 p.m. EST, Okta stock was down 9.6%. 

Okta executives at the company IPO

Image source: Okta.

So what

Interest rates on the benchmark 10-year Treasury note rose again this morning to 1.6%. As that happens, investors are adjusting discount rates on their models and moving money out of growth stocks with little profits into stocks with more reliable near-term profit streams. 

There was no major news out on Okta, though a number of analysts weighed in on the stock since the earnings report, with many lowering their price targets following the sell-off and the disappointing earnings guidance. The company also filed its annual 10-K report, and registered to award nearly 8 million shares in employee compensation, valued at close to $2 billion.

The best explanation for the stock's recent slide, however, is probably the chart below.

OKTA Chart

OKTA data by YCharts

As you can see, the company's price-to-sales ratio has steadily expanded since its 2017 IPO, especially over the last year, which means the valuation has gotten inflated. The stock price has risen faster than the underlying business fundamentals. There's no correct valuation for the stock as that depends on other market conditions, but the higher the P/S ratio gets the more the stock is vulnerable to a pullback like the one we're seeing now with the market rotating out of Okta and its high-priced cloud peers.

Now what

No one knows how long this rotation will last, but it seems like a mistake to fault Okta's guidance. The company has historically been conservative with its forecasts, and it delivered a 13% free cash flow margin in 2020, showing it is generating strong profits on a cash basis.

The Auth0 acquisition also looks like a smart move to consolidate its leadership in the cloud identity sector. Despite the current volatility, Okta still looks like a long-term winner.

 
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.