What happened
Shares of HubSpot (HUBS 2.55%) dropped 25.8% in January, according to data from S&P Global Market Intelligence. It was one of many stocks that sustained deep losses without the business reporting any sort of bad news. Multiple years of growth stock momentum have been reversing in recent months, and investors are moving capital away from growth stocks. HubSpot's valuation was too high to hold up in these market conditions.
So what
HubSpot is doing plenty of things well. The company grew 49% in its last quarter, and its adjusted earnings exceeded Wall Street's expectations. While HubSpot was unprofitable on an accounting basis, it produced positive free cash flow. It's also securing future growth opportunities with new products. Adding billing and payment transfer functions to the platform will allow HubSpot's customers to address a key pain point.
Image source: Getty Images.
HubSpot has more than 120,000 customers from all over the world. It also reports net revenue retention above 110%. The company derives sales from diverse sources, and it's both retaining and expanding relationships with those customers. Those are great signs for stability and indicate a wide economic moat.
It seems odd that a business with all of those positive characteristics could drop 25% in a single month. The reason lies in valuation and risk. HubSpot came into the year with forward P/E around 270 and price to sales above 25.
HUBS PE Ratio (Forward) data by YCharts
Those are both high valuation ratios. Those prices assume that HubSpot will continue to grow rapidly without any major disruptions for years to come. While the company is performing phenomenally well, it still competes with the likes of Salesforce.com, Adobe, Oracle, SAP, and Microsoft. That's a list of heavy hitters, so there will always be operational risk in the story. That's not compatible with high valuations when investors are taking risk off the table.
Now what
HubSpot reports quarterly earnings on Feb. 10, so there's a chance for the stock to break free from the market trend. That could be good or bad news, depending on how investors receive the announcement. The company's forecasts call for sales around $360 million and adjusted earnings around $35 million. Meeting or exceeding those expectations will be important, but it won't be enough to keep the stock supported. Wall Street will also carefully monitor HubSpot's forward-looking commentary and guidance for next year.
HubSpot isn't exactly "cheap" yet, so don't be shocked by more volatility over the next few months, regardless of the outcome of earnings this week.
