The stock market is off to a great start this year, with high growth technology stocks leading the way.
Using the Zacks Rank I have identified two stocks with strong earnings revision trends that are outperforming the market.
Zacks research shows that stocks with positive earnings revisions have a strong correlation with positive future returns.
Okta
Okta OKTA is a San Francisco based identity and access management company. Its cloud software helps manage and secure users on applications, and also helps developers create identity controls for software, websites, and web apps.
Okta is setting up like it may be a great stock for 2023, already outperforming the broad market. Last year was not so kind to OKTA as it was down 80% off its highs. But this gives it plenty of room to keep on climbing.
Okta currently holds a Zacks Rank #2 (Buy), indicating positive earnings revisions. Current quarter sales are expected to climb 28% YoY to $489 million. Current year sales growth is expected to be up 41%, bringing annual sales to $1.8 billion.
Earnings estimates have made significant moves as well, flipping from negative earnings to positive. Current quarter EPS are expected to be $0.10 per share, up from -$0.11 per share just 90 days ago, and way up from the year-ago period’s -$0.18 per share.
We can also see just how useful the Zacks earnings revision trends have been for trading OKTA. In the chart below we can see earnings began to trend lower several months before the big sell-off in the stock began. Furthermore, it looks like the earnings trend turned higher preceding the most recent rally as well. You can see just how steep the trend higher in earnings is, indicating a very strong trend.
Okta has had stunning sales growth since its IPO in 2017 and has only begun to slow. It is hard to say exactly what has caused the slowing of growth. Rather than saturating the market, it is more likely that the broad slowdown in enterprise spending is playing a major role. While that may continue to be a factor short-term, OKTA may have the potential to grow revenue at an average of 40% a year for years to come.
Currently trading at 7x prices to sales ratio, the valuation is well off its highs of 45x, and very near its low of 4x. Considering the epic growth potential of the business, and the relative valuation, OKTA has become quite appealing valuation-wise.
It is worth noting that the slowdown in business spending, especially in the tech sector, is a significant, and potentially dangerous development for the company. If the slowdown continues, or worse accelerates, OKTA may experience another challenging year. But sentiment around the software industry is quite low, so this may be a candidate for a contrarian investment.
Okta reports earnings on March 1, after the market closes.
Chewy
Chewy CHWY, the pet-centric ecommerce company is another stock that is absolutely ripping out of the gate this year. This comes after a very challenging period for the stock though, which at its worst was down 80% off its 2021 all-time high.
Chewy’s business has tremendous secular tailwinds. Pet ownership has never been higher, and an estimated 70% of households (90 million homes) have at least one pet. The vast majority of Chewy’s revenue comes from auto ship customer sales, which means their customer base pays a regular subscription. This is fantastic for their business as feeding pets is not a discretionary purchase, and makes customers very sticky.
Chewy currently sports a Zacks Rank #1 (Strong Buy), indicating persistent positive earnings revisions. Current quarter sales are expected to grow 10.7% YoY to $2.6 billion, and current year sales are expected to climb 12.9% to $10 billion.
This growth rate is a slowdown from prior years as they did 25% sales growth last year, and 47% in 2021. Nonetheless, growing sales from $3.5 billion in 2019 to $10 billion today is an impressive feat.
As for revisions, the current quarter EPS estimate has only seen a $0.01 revision higher from -$0.13, although current year and next year have been revised higher more significantly. The current year was revised from -$0.11 90 days ago to -$0.03 today, and next year revised from $0.03 90 days ago to $0.12 today. Flipping EPS positive would be a huge development for the stock.
Chewy also has a strong record recently regarding earnings surprises. It seems pet spending has not been affected much by the rapidly changing economic environment. This makes sense as pets are truly members of the home today, and families are unlikely to stop treating their pets well.
Chewy’s valuation is well off its 2021 highs. With a P/S ratio of 7x today, it is significantly off its high of 46x, and very near its recent low of 4x. Still, as an ecommerce company, with tighter margins than a software business, it’s still a fairly pricey valuation.
Nonetheless, today the market likes these types of companies and reasonably so. CHWY sees continued earnings revisions higher. Chewy next reports earnings on April 4.
Bottom Line
So far in 2023 the market really likes these high growth companies. We will find out soon enough whether it will continue.
Both CHWY and OKTA are companies that have strong sales growth and are on a path towards positive earnings. Front-running that event, along with the positive earnings revisions may be a great opportunity to invest in these stocks before the next big run.
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