What happened
Shares of Roku (ROKU 5.41%), Snowflake (SNOW 2.69%), and DraftKings (DKNG 1.63%) were all trading more than 6% lower at points on Monday, December 13, before slightly recovering.
While each of these companies plays in a different part of the economy, they do share some things in common. First, they are all very high-multiple growth stocks. Second, each is exposed in a certain way to discretionary consumption.
It appears traders are fearful of this week's Federal Reserve meeting in which officials may decide to speed up the pace of financial tightening, which could harm these types of stocks, both financially and in terms of valuations.
Image source: Getty Images.
So what
Federal Reserve officials will meet over Tuesday and Wednesday, and will likely discuss a faster tapering of their bond purchases, reflecting comments from Federal Reserve Chair Jerome Powell earlier this month. Inflation has suddenly become a concern even though economic growth is strong. The potential for a quicker tightening and earlier-than-expected rate hikes is on the table.
As we've seen over the past month or so, higher interest rates have the potential to compress growth-stock valuations, and Snowflake, Roku, and DraftKings each fit the bill.
Snowflake is reporting impressive triple-digit revenue growth of 110% but also trades at a stunningly high price-to-sales (P/S) multiple over 100. It's also losing money on its bottom line, with an operating margin of 47% last quarter.
Roku is also posting strong growth, with overall revenue up 51% last quarter and platform revenue up 81%, but it also makes minimal operating income today even though operating income is actually positive. Roku also trades at a P/S multiple over 12, which isn't nearly as high as Snowflake's. However, some of that is profit-less device revenue, so the profitable part of the business -- its multiple of platform revenue -- is higher.
Finally, DraftKings logged 60% growth in its most recent quarter but is also producing significant losses, with an operating loss that was more than twice its revenue in the third quarter!
Additionally, there is fear that a tightening of financial conditions could slow the economy and cool down the strong consumer spending we have been seeing for the past year or so. All three of the above stocks tend to rely on consumption-driven revenue, so not only could valuations compress, but revenue could slow too.
Roku gets all its profitable revenue from ad revenue and consumer discretionary spending on streaming services. If consumer spending dips, ad revenue growth could slow more broadly, affecting Roku's growth.
The same goes for DraftKings. If consumers have less discretionary cash lying around to spend, they are less likely to gamble on sports. DraftKings may also be feeling an extended hangover from last week when noted short-seller Jim Chanos revealed he was short DraftKings' stock.
Finally, a difference between Snowflake's business model and other enterprise software companies is that Snowflake operates on a consumption-based model instead of a subscription model. As shown in its recent results, its enterprise customers are consuming quite a lot. However, if the economy slips, that consumption growth could slow down. Additionally, investors were likely not happy to see Snowflake's Chief Financial Officer Michael Scarpelli selling $22 million worth of shares on December 8. However, that number, which seems quite large, is actually a small part of Scarpelli's total holdings.
So, the combination of potentially cooling consumer spending, the threat of higher interest rates, and some company-specific warnings seems to be driving down the share price of each company today.
SNOW Percent Off All-Time High data by YCharts
Now what
Snowflake does seem to be in a different place from Roku or DraftKings as it's only 16% below its recent all-time highs, while Roku and DraftKings are each down more than 50% from all-time highs set earlier this year.
While each one is a low- or no-profit growth stock, Snowflake mainly serves enterprises, and its market-leading product appears to be a "need-to-have" data-management tool. In contrast, Roku and DraftKings are more tied to discretionary consumer spending.
It appears the market is more worried about the U.S. consumer in the face of inflation and rate hikes than it is about digital-transformation tools for enterprises. Still, each stock remains vulnerable to multiple compression even at these lower levels. Investors are suddenly turning their attention to a company's bottom line and not just the top line, so investors may want to think harder about how much profit -- and not just revenue -- each of these high-growth companies can make in the future.
