Share prices of identity management software giant Okta (OKTA -1.79%) are up nearly 70% from multiyear lows set in November 2022. It's a welcome reprieve for the cloud computing technologist, which was blasted by the bear market of 2022. The stock remains down over 70% from all-time highs last reached in early 2021, even after the nearly 70% rally over the last six months.
Okta is getting its finances in order after it was exposed for being deficient in the profitability department. But after the big rebound, is it too late to buy Okta stock?
Identity management is part of the cybersecurity megatrend
As the world continues to adopt more digital tools, cybersecurity is becoming a mission-critical service. Various estimates point toward annual global spending on cybersecurity to grow at a high-single-digit to low-teens percentage every year through the end of the 2020s. This would make the overall security software market worth more than $300 billion a year.
An important subset of cybersecurity is identity and access management (IAM). IAM became even more important during the COVID-19 pandemic when remote work and work-from-home became far more common. Thanks to advances in cloud computing, it's now possible for employees to log in to work apps and access company data from anywhere, from any device. But that also introduces the possibility for hackers to also gain access, impersonating an employee's credentials.
That's where Okta comes in. Okta is a leader in IAM, giving organizations the ability to authenticate and authorize employee access to apps. And with the acquisition of Auth0 in 2022, Okta also bolstered its platform with general user access to applications (like customer-facing app access).
But there's big competition in the fast-growing IAM space, Microsoft and its $20 billion-a-year cybersecurity empire among them. In fact, tech researcher Gartner has consistently named Okta and Microsoft side-by-side as leaders in IAM software technology. Nipping at their heels on Gartner's list are other players like ForgeRock and Ping Identity (both of which were acquired by private equity investor Thoma Bravo in 2022, along with IAM peer SailPoint), CyberArk, and Oracle.
Intense competition and a slowing digital economy
Indeed, as great as Okta's services may be, intense competition from a myriad of other security service vendors is one reason to be wary. Top security industry company Palo Alto Networks CEO Nikesh Arora has said cybersecurity "is the most innovative industry" because of the constant need to stay ahead of the bad guys, as well as the need to stay ahead of upstart players with new security offerings. This leaves the door open to losing technological leadership, which can be a death knell for a stock like Okta.
Slowing economic growth can also be a serious problem. After more than a decade of hypergrowth, even the cloud computing space is expected to hit a soft patch in 2023 as economic worries come to a head. Okta's outlook for the year ahead is for revenue to grow "only" 16% to 17% year over year, which includes one more small bump in the first quarter from the takeover of Auth0 last May. That's in sharp contrast to the more than 40% revenue growth Okta notched every year since its IPO in early 2017 (including the recently concluded 2023 fiscal year, which ended in January 2023 with a growth of 43%).
Does rising profitability make Okta stock a buy?
One big reason Okta stock was clobbered the last couple of years was it operates deep in the red. Generally accepted accounting principles (GAAP) net loss was $815 million last year (fiscal 2023), and the adjusted net loss was $7 million. The big discrepancy between the two metrics was primarily attributable to employee stock-based compensation of $677 million, which effectively lowers Okta's revenue growth (and future profitability) on a per-share basis in a grandiose fashion.
Data by YCharts.
Nevertheless, the company is working on getting itself fit and is expecting to swing to an adjusted profit of at least $136 million in the next year (a figure that should roughly align with free cash flow generation, which was $63 million last year). If revenue increases to at least $2.15 billion, as management forecasts, that would be an adjusted operating profit margin of about 6% to 7%.
Though there are signs of progress, Okta still has its work cut out for it to get itself in good financial shape.
Given the present situation, I'd use caution before chasing the recent rebound in Okta stock. Though there could be plenty of growth for the identity and access management niche of cybersecurity in the years to come, Okta still needs to prove the merits of its business' financial structure. And because it trades at over 6 times trailing-12-month sales (and well over 5 times expected one-year forward sales), I see far more compelling buys right now in the cybersecurity market.
