What happened
Shares of high-flying growth stocks ran into a marketwide correction in December 2021, according to data from S&P Global Market Intelligence. For example, freelance services specialist Fiverr International (FVRR -1.17%) took a 19.7% haircut last month, while data search company Elastic (ESTC 2.26%) saw a 20.8% price cut. Web security and infrastructure expert Cloudflare (NET 0.70%) dropped even further, recording a December decline of 30.1%.
So what
These price drops were part of a larger trend stretching back to mid-November and continuing into January. As a result, all of the stocks mentioned above have lost more than 40% of their value since Nov. 16.
Elastic stands apart in this group as the only company that had significant news to report in December. Share prices fell hard on Dec. 1 as the company reported beat-and-raise results for the second quarter of fiscal year 2022. Monness Crespi analyst Brian White said what you're probably thinking about that market reaction when he called the price cut "silly" and reiterated his buy rating on the stock. Even that move was soon forgotten as the stock reverted to the same general trajectory as the other high-growth tech stocks in this study.
Image source: Getty Images.
Investors had a lot to worry about last month. The now-ubiquitous omicron variant of COVID-19 had just been flagged as a variant of concern. Economic data showed inflation rates surging to historic levels. The whole cryptocurrency boom that started in the fall of 2020 was grinding to a halt amid these market concerns and heavy-handed regulatory action in China and India. Many risk-averse investors reacted to these market trends by rotating out of risky growth stocks in favor of safer investment vehicles such as bonds, value stocks, gold, or real estate.
Fiverr, Elastic, and Cloudflare share a few attributes that made them easy targets for this broad-based risk correction:
- They all have above-average short interest. As of Dec. 1, the percentage of shares being sold short ranged from 2.6% for Cloudflare to 8.3% for Fiverr. To give these figures context, the ultra-risky meme stock pariahs Gamestop and AMC reported short interest at or below 2.5% at the same time.
- They routinely post massive top-line growth numbers. In their most recent quarterly reports, Fiverr and Elastic reported year-over-year sales growth of 42%. Cloudflare ran ahead of the pack with a 51% revenue increase.
- Their bottom-line results are consistently negative and their cash profits are razor-thin at best. Unprofitable growth stocks are prone to wilder market swings than their profitable brethren because positive earnings and cash flows give value investors a stronger financial foundation around which comprehensive market values can be modeled.
Now what
The growth stocks under our microscope are now trading far below their recent highs. Elastic and Cloudflare have plunged 41% and 50% lower in six weeks, respectively. Fiverr's downward spiral started in mid-February, adding up to a hair-raising 72% crash.
That's all good if you agree with the bears that high-flying growth stocks were overdue for a radical correction. Personally, I look at these lower share prices as an invitation to pick up a new growth stock or add to an existing position -- spring-loaded for a dramatic rebound as the general market fears subside. Just make sure that the companies you're looking at are high-quality businesses that should be able to make it through a limited period of harsh market conditions. Elastic, Fiverr, and Cloudflare all fit that bill for me.
