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Are High-Growth Stocks in Danger of Big Declines?

By Dan Caplinger – Updated Jul 30, 2021 at 2:36PM

Key Points

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Markets were broadly lower, but some former darlings of the market did quite a bit worse.

High-growth stocks have been strong performers over much of the past year. Yet investors seem increasingly nervous about whether they'll be able to sustain their past growth rates. It's partially because of those concerns that the stock market overall suffered losses on Friday. As of 1:30 p.m. EDT, the Dow Jones Industrial Average (^DJI 0.10%) was down 134 points to 34,951. The S&P 500 (^GSPC -0.12%) dropped 21 points to 4,398, and the Nasdaq Composite (^IXIC -0.18%) lost 95 points to 14,683.

Big-name stocks were among the decliners on Friday, but a couple of smaller high-growth tech companies stood out for outsized drops. Both Upwork (UPWK 2.06%) and Zendesk (ZEN) suffered double-digit percentage losses on Friday afternoon, and that has some investors wondering whether a broader correction or bear market for high-growth stocks could be in the cards. Below, we'll look at what sent these two companies lower.

Blindfolded person stepping out over a chasm.

Image source: Getty Images.

Upwork works its way down

Shares of Upwork fell 12% Friday afternoon. The latest results from the provider of a marketplace for freelancers and service buyers to connect didn't live up to high expectations, and shareholders were left wondering if the future will look brighter.

On its face, Upwork's second-quarter financial report looked solid. Gross services volume climbed 50% from year-ago levels to $876 million, and growth in core client counts accelerated to 21%, with Upwork seeing 162,000 core customers during the period. Client-spend retention rose to 114%, reflecting increasing spending among repeat buyers sticking with the Upwork platform.

However, headline numbers from Upwork were mixed. Revenue rose 42% to $124 million, but take rates fell by nearly a full percentage point to 14.2%. That led to a wider net loss from the second quarter of 2020 and also came in weaker than most investors following Upwork had expected. However, on an adjusted basis, Upwork's earnings of $0.03 per share reversed a similar-sized loss in the year-ago period.

What might have spooked Upwork shareholders the most was guidance for year-over-year revenue growth in the third quarter to slow to around 30%. Whenever high-growth stocks start to see deceleration take hold, it can be hard for their share prices to hold up.

Zenning out

Elsewhere, Zendesk's stock fell an even sharper 14% on Friday afternoon . The move lower also came after the release of the company's Q2 financial results, as investors cooled on the customer service software provider's prospects.

Zendesk's numbers were reasonable. Revenue of $318 million was up 29% year over year. Adjusted net income inched higher, although a rise in share counts sent earnings per share lower from year-ago levels. The company said it added more than 50 new large customer accounts in the quarter, with expectations that each will contribute more than $250,000 to its annual recurring revenue.

Some investors weren't satisfied with Zendesk's guidance. The company expects revenue of $332 million to $337 million in Q3, which isn't any more than what most investors had already foreseen. Full-year revenue of $1.31 billion to $1.318 billion similarly suggests that growth might slow down.

In the long run, the success of many high-growth stocks will depend on whether the unprecedented economic conditions during the beginning of the COVID-19 pandemic will prove to be the catalyst for favorable longer-term trends or just a one-off bump that goes away in the months to come. For those that fail to sustain their momentum, share-price losses like these could become commonplace.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Zendesk. The Motley Fool recommends Upwork. The Motley Fool has a disclosure policy.

Stocks Mentioned

Upwork Stock Quote
Upwork
UPWK
$12.38 (2.06%) $0.25
Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
^DJI
$34,429.88 (0.10%) $34.87
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
^GSPC
$4,071.70 (-0.12%) $-4.87
NASDAQ Composite Index (Price Return) Stock Quote
NASDAQ Composite Index (Price Return)
^IXIC
$11,461.50 (-0.18%) $-20.95
Zendesk Stock Quote
Zendesk
ZEN

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

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