For a second consecutive year, the bulls are running wild on Wall Street. While most investors love a good bull market, it can make locating good deals more challenging.
As of the closing bell on April 10, the S&P 500's Shiller price-to-earnings (P/E) ratio (also known as the cyclically adjusted price-to-earnings ratio, or CAPE ratio) registered one of its highest readings dating back more than 150 years.
Unlike the traditional P/E ratio, which takes into account trailing-12-month earnings, the Shiller P/E ratio is based on average inflation-adjusted earnings from the last 10 years. In other words, it removes one-off events from the equation to provide an encompassing view of stock valuations. The Shiller P/E ratio's closing value of 34.26 on April 10 is double the average reading since 1871 and an ominous warning, based on history, that equities are due for a sizable pullback.
Image source: Getty Images.
Despite these numerous warnings that a stock market correction or even a bear market could emerge in the not-too-distant future, I continue to search for value among growth stocks. Though the pickings have admittedly been slim, one growth stock has checked all the right boxes and encouraged me to pull the trigger and nearly double my stake.
Investors of all ages, say hello to edge computing company Fastly (FSLY 0.15%). The company is best known for its content delivery network (CDN), which is tasked with quickly and securely moving data from the edge of the cloud to end users.
How Fastly lost its edge
No matter how much an investor likes a stock, it's important to recognize that headwinds always exist. There's not a single publicly traded company that isn't contending with some sort of competitive or macro-based challenge. For Fastly, there are a few clear reasons why the company has retraced about 90% from its all-time intraday high of $136.50, set in October 2020.
To begin with, Fastly was taken on an emotional roller-coaster ride during the COVID-19 pandemic and was one of the investing superstars during pandemic-driven lockdowns. The thinking was that if people are stuck in their homes, more content will be trafficked through Fastly's CDNs. When COVID-19 vaccines hit pharmacy shelves and life returned to some semblance of normal, this emotional investing euphoria wore off.
Another problem for the company is that it failed to push into the recurring-profit column. While there was a period during the COVID-19 pandemic when investors gave little thought to stock valuations, the 2022 bear market put traditional fundamental valuation metrics back into focus. A myriad of expenses, which included the ongoing expansion of Fastly's CDN network in international markets, led to the company losing more money than Wall Street's analyst consensus anticipated.
To add to the above, prior CEO Joshua Bixby allowed stock-based compensation (SBC) to get out of hand. When Bixby took the reins in 2020, SBC more than quintupled to $64 million. In 2021, SBC more than doubled again to about $140 million. While SBC can be a nice incentive for employees of the company, it tends to dilute existing shareholders.
With Fastly continuing to lose money, the company has a lot to prove to Wall Street and its shareholders.
Image source: Getty Images.
Here's why I nearly doubled my position in Fastly stock in March
The good news is that we've started seeing demonstrable improvement in many of Fastly's key performance indicators (KPIs). What was the impetus for me to nearly double my position in March? Fastly's steady improvement where it counts, much-needed management shakeup, and enticing long-term potential.
Arguably the top catalyst for Fastly was the hiring of Todd Nightingale as CEO in August 2022 (effective Sept. 1, 2022). Nightingale came from Cisco Systems, where he was the head of the company's Enterprise Networking and Cloud segment. While Nightingale has a good understanding of what growth initiatives Fastly can take advantage of, his biggest contribution is what he's been able to take away.
Under Nightingale's leadership, Fastly's SBC has shrunk for the first time in the company's history, while research and development and general and administrative expenses have remained relatively flat. For a company with sustained double-digit sales growth, stagnant costs equate to a steady increase in adjusted gross margin. Since taking over, Nightingale has overseen a 640 basis-point expansion in generally accepted accounting principles (GAAP) gross margin to 55%.
FSLY Gross Profit Margin (Quarterly) data by YCharts.
In addition to a substantial margin improvement, most of the company's KPIs signal high satisfaction with its CDN services. Fastly's aggregate enterprise customer count and average spend per enterprise client continue to hit new highs. Meanwhile, its annual revenue retention (ARR) rate rose 30 basis points to 99.2% in 2023. An ARR rate above 99% clearly shows that the company's customers are sticking around.
Best of all, Fastly's dollar-based net retention rate (DBNER) has been pinned between 118% and 123% over the last eight quarters (ended Dec. 31, 2023). What DBNER indicates is that existing customers are spending an average of 18% to 23% more on a year-over-year basis. Since Fastly is predominantly a usage-driven platform, the company's KPIs are signaling that existing clients love the platform and are continuing to grow their spending by a double-digit percentage.
On a macro basis, Fastly is in a prime position to benefit from businesses continuing to move their data online and into the cloud. As demand for online content grows, so should the amount of data traversing Fastly's CDN.
Although Fastly's operating performance isn't going to turn on a dime, the groundwork has been laid for the company to turn the corner to recurring profitability in 2025 or even the latter half of the current year. If Fastly comes anywhere close to achieving Wall Street's consensus of 30% annualized earnings growth through 2028, the shares I added in March will be nothing short of a bargain.
