Please ensure Javascript is enabled for purposes of website accessibility

Have $1,000? The Tech Sell-Off Just Put This Stock on Sale.

By Jason Hawthorne - Updated May 16, 2021 at 3:33PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

A great business in a rapidly growing industry won't stay on sale for long.

With the recent hack of Colonial Pipeline leading to gas shortages on the East Coast, it's clearer than ever why company executives have security as a top priority. Many are implementing an idea known as "zero trust." Just like it sounds, it's a policy of not trusting anyone. In practice, it essentially eliminates all access to a network until a user has been authorized.

One of the beneficiaries of the shift has been Okta (OKTA -6.50%), a software-as-a-service (SaaS) provider of identity management solutions. Although the company has seen tremendous tailwinds from the heightened security requirements of remote work, its stock sits more than 20% off its highs after the recent sell-off in technology stocks. Let's look at why that drop is short-sighted.

A young woman holding a mobile phone with the virtual icon of many applications hovering around her.

Image source: Getty Images.

In the right place, at the right time, making all the right moves

There aren't many better industries right now than cybersecurity. It's an estimated $162 billion market slated to grow to over $400 billion by 2028. With the shift to zero trust, Okta's Identity Cloud is perfectly positioned. It harnesses the power of cloud computing, as well as mobile and web-based technologies, to create a central system of access for a company's employees. At the end of January, Okta had more than 10,000 customers in nearly every industry around the globe.

The system is used in two ways. First, companies are able to authenticate employees, contractors, and partners when they attempt to access the company's internal network in any way. This process is called workforce management. Okta's customers can also layer in its security to provide authentication for their own customers. That's the second application, called customer identity. Unlike some legacy vendors that need to unseat a competitor's products to sell their own, Okta has more than 7,000 integrations with other technology leaders. That helps it play a vital role -- identity management -- in a larger cybersecurity landscape. Among the partnerships are integrations with titans such as Amazon.com's Amazon Web Services, Alphabet's Google Cloud, and Microsoft, as well as endpoint protection leader Crowdstrike.

Profitably growing into an expanding addressable market

Okta's SaaS business model generates most of its revenue through multiyear subscriptions to its cloud-based offerings. Management believes the workforce identity market is roughly $30 billion and the potential of the customer identity is about $25 billion. With less than $800 million in sales in the fiscal year ending Jan. 31, the company has a huge opportunity if it can add customers and deepen the relationship with existing ones. It's knocking the ball out of the park in both areas. 

Since a SaaS business can only recognize revenue over the life of the contract, revenue growth can often understate the true expansion. Okta grew revenue 44% last year and remaining performance obligations (RPO) -- sold work that has yet to be recognized as revenue -- by 49%.

Fiscal Year Ending Jan. 31 Revenue Revenue Growth RPO RPO Growth
2021 $797 million 44% $1.8 billion 49%
2020 $553 million 49% $1.2 billion 66%
2019 $371 million NA $729 million NA 

Data source: Okta.

The number of customers with an annual contract value (ACV) greater than $100,000 continued to grow at a rapid clip, while dollar-based net retention remained incredibly high. That net retention number over 100% means that growth from existing customers more than offsets any churn. Seeing it remain at that elevated level means revenue is compounding year after year even if no new customers are added. Toss in the growth in large contracts, and you have the recipe for hypergrowth.

Okta is adding new customers, too. Nearly half of the customers with ACV greater than $100,000 added last quarter were new customers. That represents large customers that the company is taking from legacy vendors such as Oracle and IBM. Okta is growing on all fronts. 

Fiscal Year Ending Jan. 31 Customers With ACV > $100,000 Growth in Customers With ACV >  $100,000 Net Revenue Retention
2021 1,950 33% 121%
2020 1,467 41% 119%
2019 1,038 NA 120%

Data source: Okta.

Management recently took a leap forward by agreeing to acquire Auth0 for $6.5 billion in stock. It was a brilliant move to eliminate a strong competitor without spending any cash. Okta also gained a valuable tool to help developers embed identity management into even more applications.

Another offering should accelerate the company's transition to a cash-generating business. Its cash from operations and free cash flow indicate it can become a profit machine for shareholders whenever it decides. That said, there is no reason to stop investing now, with such high growth rates and low penetration of the addressable market. 

Fiscal Year Ending Jan. 31 Cash From Operations Growth in Cash From Operations Free Cash Flow FCF Margin
2021 $128 million 129% $111 million 13%
2020 $56 million 273% $36 million 6%
2019 $15 million NA ($7 million) (2%)

Data source: Okta.

Great businesses are never cheap

Okta's mission is to bring simple and secure digital access to people and organizations everywhere. Its value is evident in the growth numbers, and its cash flow is indicative of a great business just getting started. Unfortunately, great businesses are never cheap.

Okta currently trades at a price-to-sales ratio of 35. That's about as cheap as it has been since early in the pandemic, but it still isn't actually cheap. Management estimates full-year revenue to come in between $1.08 billion and $1.09 billion. Some estimates suggest Auth0 could add about $300 million to that number this year. Projecting that for the fiscal year ending January 2022, the stock trades at about 25 times forward sales. For context, it consistently traded around that number from the summer of 2019 through the beginning of the pandemic. Once investors realized the security implications of remote work, it jumped higher.

Ultimately, the valuation will work itself out over time if management keeps executing. So far, every indication is that they will. Thanks to the recent sell-off in tech stocks, this industry leader is finally on sale again. If history is any indication, it might not last long.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Jason Hawthorne owns shares of CrowdStrike Holdings, Inc. and Okta. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, CrowdStrike Holdings, Inc., Microsoft, and Okta. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Okta Stock Quote
Okta
OKTA
$95.16 (-6.50%) $-6.61
Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$286.64 (-1.22%) $-3.53
Alphabet Inc. Stock Quote
Alphabet Inc.
GOOGL
$117.90 (-1.89%) $-2.27
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$139.14 (-2.22%) $-3.16
International Business Machines Corporation Stock Quote
International Business Machines Corporation
IBM
$138.52 (-0.40%) $0.55
Oracle Corporation Stock Quote
Oracle Corporation
ORCL
$78.67 (-0.82%) $0.65
Alphabet Inc. Stock Quote
Alphabet Inc.
GOOG
$118.64 (-1.84%) $-2.22
CrowdStrike Holdings, Inc. Stock Quote
CrowdStrike Holdings, Inc.
CRWD
$189.79 (-3.05%) $-5.97

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
397%
 
S&P 500 Returns
128%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/19/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.