These best-in-class digital transformation names in cloud data lakes, cybersecurity, and application observability are all at the cutting edge of enterprise innovation today. However, they are all very high-priced growth stocks. Since the economy seems to be slowing at a rapid pace and each stock has had a nice run over the past few weeks, it appears investors are taking chips off the table ahead of earnings.
CrowdStrike did unveil a new innovation today, but it appears macroeconomic issues enhanced by a bad growth outlook from the International Monetary Fund (IMF) is overwhelming any company-specific news today.
On Tuesday, the IMF revised down its estimates for global growth in 2022, to just 3.2%, down from 6.1% last year and down from its initial estimates heading into this year. In an accompanying blog post, the IMF said, "The risks to the outlook are overwhelmingly tilted to the downside," citing higher-than-expected inflation, a strong U.S. dollar, the war in Ukraine, and Chinese lockdowns as factors.
Lower growth wouldn't be good for anyone, especially growth stocks. However, it is interesting that these three marquee names in the space are selling off so much. Amid recession concerns, the 10-year Treasury bond yield is actually down today, to around 2.78%, down from a high of 3.48% in mid-June and even 3% as recently as last week. Typically, when long-term bond rates go lower, growth stocks like these three will respond favorably.
However, these stocks still fell today. This could be because of upcoming earnings season, which is making investors nervous. U.S. companies with significant international businesses could be under pressure under a very strong U.S. dollar, which has the potential to hurt headline revenue and earnings growth.
Finally, there is a big Federal Reserve meeting tomorrow, followed by a press conference with Chair Jay Powell. Investors may also be getting nervous about the tone from the Fed, which will give color on the inflation outlook and the path of interest rates.
In short, there are a whole host of worries, and profitless growth stocks like these don't have a valuation cushion to fall back on, at least in terms of profits. Given that these types of stocks were driven by revenue growth and momentum over the past few years, the current growth scare is now affecting them in the opposite fashion. These three stocks are still hanging above their prior lows set back in June, but it remains to be seen if we will test those levels again.
In individual company news, CrowdStrike unveiled its cloud native application protection platform (CNAPP), which expands the company's cloud-native security capabilities to applications built on containers running in the cloud.
Interestingly, the new innovation could actually set CrowdStrike on a competitive collision course with companies like Datadog that play in the same field of protecting and monitoring cloud software applications. That is certainly a trend to monitor, as cybersecurity and observability continue to overlap more and more.
In highly uncertain times like these, investors should look to stocks backed up by high quality and competitive advantages, as well as valuation. While these three certainly have the former, as shown by their high growth rates, their valuations are still high, with price-to-sales ratios over 20, even though these stocks are down a lot to start the year. While each of these names belongs on your watch list, I'd still be cautious about adding, due to these valuation concerns.
Although stocks that can grow tend to outperform others when growth is scarce (as in a recession), a lot of growth is priced into these names. How much? It's hard to say.
I'd encourage interested investors in these names to build a discounted cash flow model based on assumptions about future profitability. That could shed more light on the right price to pay, rather than trying to guess based on attractive stories and multiples of revenue.