A lot of stocks had really good years in 2019. That’s why the S&P 500 posted its best annual return since 2013. But, one enterprise software stock which had a particularly strong 2019 was cloud security company Okta (NASDAQ:OKTA).
In many ways, Okta was the stock of the year in the enterprise software world. OKTA surged nearly 80% higher last year, as the company pioneered a new method of identity-based security which companies everywhere found highly attractive. Hundreds of companies signed up for this novel security platform, called Identity Cloud. Revenues and margins stormed higher. So did OKTA stock.
Now, the 2019 enterprise software stock of the year looks positioned to have a big 2020, too.
Specifically, three big catalysts will propel OKTA stock meaningfully higher next year. First, revenue growth rates, which have been slowing throughout 2019, will stabilize in 2020. Second, profit margins, which have been improving throughout 2019, will continue to improve in 2020, and potentially even sneak into positive territory by year end. Third, Okta’s valuation, which is discounted relative to the company’s long-term profit growth potential, will meaningfully expand.
All together then, Okta stock could be the enterprise software stock of the year again in 2020.
Okta’s Fundamentals Are Improving
The big idea behind the 2020 bull thesis in OKTA stock is that, over the course of the next 12 months, Okta’s core fundamentals will meaningfully improve, laying the foundation for share price gains.
These improvements break down into two parts — revenue growth stabilization and continued progress toward profitability. On the first part, Okta’s revenue growth rates have slowed significantly in 2019, from 50% at the start of the year to 35% exiting the year. With revenue growth rates now down near 30%, however, the laps are getting much easier for Okta, so there shouldn’t be much more revenue compression in 2020, assuming the company’s core tailwinds remain favorable.
They should. Okta sells identity-based, cloud security solutions to enterprises across the globe. In 2019, corporate spending on such items dropped because of escalating geopolitical uncertainty. Now, that uncertainty is fading from the scene thanks to easing trade tensions. Corporate spending on things like cloud security should rebound in 2020. This rebound should help stabilize Okta’s revenue growth rates.
On the second part, Okta’s gross profit margins have been improving all year long. But, operating losses have not been narrowing, since the company is spending an arm and a leg to grow. This robust expense growth should moderate in 2020, as Okta gets bigger, spends less on marketing and benefits more from macroeconomic tailwinds. As it does, Okta will make more meaningful progress toward profitability. Considering fourth-quarter operating loss is projected to be just $10 million, it is fairly likely that by the second half of 2020, Okta peeks its head into profitable territory.
Broadly, this combination of revenue growth stabilization and strong progress towards profitability should drive OKTA stock higher in 2020.
Okta Stock Is Undervalued
By my numbers, this 2019 enterprise software stock of the year is materially undervalued at current levels.
Okta is growing revenues at a 30%-plus clip. The company will sustain 20%-plus revenue growth over the next several years for a few reasons. First, the amount of data and operations pivoting into the cloud is growing exponentially, and the amount of money corporations will spend on cloud security to protect all that data and those operations will grow exponentially, too. Second, identity-based cloud security solutions will attract the lion’s share of that cloud security spending, because they optimize for work-flow flexibility. Third, Okta offers the best-in-class identity-based cloud security solution out there, so it will win big as adoption of identity-based cloud security solutions rises.
Meanwhile, Okta is an 80% gross margin business with a huge operating expense rate. That high gross margin will stay high because this is an enterprise software business with strong pricing power and very little cost of production. That big opex rate will drop over time because expense growth will moderate as new client growth slows, and as spending per client rises. This combination ultimately implies huge room for margin expansion in the long run.
Okta reasonably projects as a 20%-plus revenue grower for a lot longer with huge margin upside potential. Looking out long term, my modeling pegs Okta’s calendar 2030 earnings potential at $11 per share. Based on an application software sector average 35-times forward earnings multiple, that implies a 2029 price target for OKTA stock of $385. Discounted back by 10% per year, that equates to a calendar 2020 price target of over $160.
OKTA stock presently trades hands around $117. That’s well below $160. Thus, this 2019 stock of the year could turn into a 2020 stock of the year, too.
Bottom Line on OKTA Stock
Okta stock had a big 2019, rising nearly 80%. Shares could have another big year in 2020, as favorable fundamentals converge on what has become a relatively discounted valuation.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.