What happened
Shares of Elastic NV (NYSE: ESTC) plummeted 24.2% in January, according to data provided by S&P Global Market Intelligence. The enterprise search and data company announced a transition for its CEO and got pushed down by the broad sell-off in growth stocks last month.
So what
On Jan. 12, Elastic put out a press release announcing its founder and CEO, Shay Banon, would be stepping down and resuming his role as chief technology officer. Current chief product officer Ash Kulkarni will be taking over as CEO. Shares of the stock sold off 8% the day following the announcement. It is unclear why the company decided to make this change, but investors tend to not like uncertainty, so it is no surprise the stock is down on the news.
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Unprofitable high-growth stocks like Elastic have gone through a huge correction in the last few months. Elastic stock is currently down 47% in the last three months alone, with a good portion of the decline coming in January. No one can know for sure why investors decided to sell growth stocks now, but a likely culprit is the Federal Reserve signaling it will start raising interest rates in March. When interest rates rise, that means stocks typically start to trade at lower valuations. For companies like Elastic that are fast-growing, unprofitable, and trade at premium valuations, small changes in interest rates can create major volatility in share prices.
Does this mean Elastic's business is now "worth" 50% less? No, far from it. This is just typical market volatility that occurs for all stocks at some point in their history. Even Apple, the largest company in the world that has created immense wealth for long-term shareholders, has experienced three 70%+ drawdowns in its history. These drawdowns are just the price of doing business in high-growth land. If you are an investor in Elastic stock, you should expect this type of thing to occur from time to time, and if you are not comfortable with seeing prices drop 50% in value, then it is best you avoid this riskier section of the stock market.
Now what
With the stock down so much from its all-time high, Elastic now trades at a price-to-sales ratio (P/S) of 10, which is the lowest it's been in the last five years excluding the March 2020 crash. With revenue growing 42% year over year with strong gross margins of 74%, now could be a great time to buy Elastic stock if you are confident in the business' prospects over the long term.
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Brett Schafer has no position in any of the stocks mentioned. The Motley Fool owns and recommends Apple and Elastic. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.
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