F5 Networks stock (NASDAQ: FFIV) is up more than 40% since the beginning of 2020, and at the current price of around $200 per share, we believe that F5 Networks stock has more than 15% potential downside.
Why is that? Our belief stems from the fact that F5 Networks stock is up around 2.2x from its March low. Further, after posting mixed Q1 2021 numbers, and with rising expenses, we believe FFIV stock could drift lower. Our dashboard What Factors Drove 24% Change In F5 Networks Stock Between 2018 And Now? provides the key numbers behind our thinking, and we explain more below.
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F5 Networks saw a 9% rise in the revenue per share which, combined with a 13% increase in the P/S multiple, which led to the stock rising 24% since late 2018.
F5’s P/S (price-to-sales) ratio dropped from 4.6x in 2018 to 3.7x in 2019, but has since jumped to 5.2x currently, riding the rally in technology stocks. However, given F5’s mixed Q1 ’21 performance, there is possible downside risk for the P/S multiple.
So what’s the likely trigger and timing to this downside?
The global spread of coronavirus and the resulting lockdowns in early 2020 have led to an increase in online activity as people are spending more time on the internet. F5 is in the business of application services and application delivery networking, and its revenues have benefited from this surge in browsing, as is evident from F5’s Q1 2021 earnings, where revenue rose to $625 million from $569 million for the same period last year. However, a rise across all expense heads saw gross margins drop from 84.4% to 81.5% and operating margins drop from 21.4% to 18.85%. This led to EPS dropping from $1.62 in Q1 ’20 to $1.43 in Q1 ’21.
Going forward, we expect revenues to stay strong in the near to medium term, but if the company is not able to control expenses, we believe the stock will see its P/S multiple decline from the current level of 5.2x to around 4.5x, which combined with a reduction in revenues and margins could result in the stock price shrinking to as low as $165, a downside of more than 15% from the current price of $201.
While F5 Networks stock may be overvalued, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Amazon vs Etsy. Another example is Apple vs Microsoft.