While US markets have rallied to new high after new high in recent years, obviously not every stock has participated. One name that’s significantly underperformed is digital operations management company PagerDuty (NYSE:PD). Shares have lost more than 42% over the past five years, and even more from their 2021 peak, as revenue growth rates have dropped and revenue estimates have come down meaningfully. In a little more than a week, the company will report quarterly results, with a bit of pressure on management to deliver some good news.

Previous coverage on the name:

It was back in June 2023 when I last covered the name, at a time in which shares dropped after the company cut its revenue guidance for the fiscal year. I noted how its paid customer count had just declined on a sequential basis, with some other key metrics showing slowing growth. I stated that if those trends continued moving forward, shares likely would not have much upside.

I was curious at that time to see how notable ETF manager Cathie Wood might react to the poor report. The flagship ARK Innovation ETF (ARKK) and ARK Next Generation Internet ETF (ARKW) owned almost 10% of the stock’s reported float, making Ark Invest one of PagerDuty’s biggest supporters. Unfortunately, since I last looked at the name, shares have declined almost 15%, while the S&P 500 is up almost 33%, but Cathie Wood has mostly held firm.

How things have looked recently:

That earnings report I covered last year was significant, not only for the guidance cut. The company beat street revenue estimates by less than $350,000. While beats are always good, that small beat snapped a ten-quarter streak of beats over one million dollars. Since the streak ended, there was one massive quarterly beat of over $2.75 million, but also three beats under a million and even a miss in the company’s latest report.

The biggest concern recently has been the company’s revenue growth rate. As the chart below shows, things have gone steadily downhill over the last year plus, after multiple years where the top line grew over 25% every single quarter. For next week’s report on fiscal Q2 2025, the July 2024 ending period, analysts are expecting a little bump higher in sales growth, but still a number that’s only in the high single digits, percentage wise.

The street is expecting top-line growth to accelerate into the mid-teens at the beginning of the next fiscal year. In the company’s most recently reported quarter, the year-over-year revenue increase was under $8 million, with the average estimate currently for the to be reported quarter a little under $9 million. However, over the next year, that number is expected to nearly double to over $15 million. Even though revenue estimates have come down quite a bit over the past 18 months, the company needs to prove it can really re-accelerate its top-line growth.

A couple of PagerDuty’s key metrics show this process could be an uphill battle. The number of annual recurring revenue customers over $100,000 has seen its year-over-year growth go from 197 to 47 in the past two years. The dollar-based net retention rate has gone from 126% to 106% over that time. Perhaps the only good news recently was a $100 million share buyback plan that was announced, which could start to get the share count down over time.

Why it is time to deliver:

There are two reasons I think this earnings report is important, and not just because of a possible major move in shares afterwards. If the company does disappoint, and the stock continues to underperform, it might be ripe for an activist. With a market cap of under $2 billion at the end of last week, a major investor with even $100 million could come in and push for major changes or perhaps a sale of the company.

The second reason has to do with what I mentioned above, and that is Ark Invest. In recent months, Cathie Wood has shown she’s willing to sell some of her underperforming tech names that are included in both the flagship innovation and internet ETFs. For example, Twilio (TWLO) and Zoom (ZM) have been completely exited so far in 2024. Ark owned 9.56% of PagerDuty’s outstanding shares as of last Thursday (more than 9 million shares between ARKK and ARKW, based on total shares of 95.6 million), a percentage that could be even higher now based on share repurchase program activity. If Ark Invest decided to start selling, or even completely exit, that could put a lot of pressure on PagerDuty shares for a time.

Checking in on the valuation:

At the moment, PagerDuty is rather fairly valued in my opinion. The stock finished last week going for about 29 times its adjusted fiscal year expected earnings and a little more than 4 times expected sales. This is an application software company not growing that much currently, with GAAP losses and basically all of its free cash flow comping from stock-based compensation. If revenue growth was a bit higher and, maybe, there were some real profits, we’d probably be looking at a price to sales number in the high single digits, along with a P/E more in the 40-50 range.

Currently, street analysts are fairly bullish on the name, like they are for most technology stocks. The average price target is $25.55, which implied almost 27% of upside from last Friday’s close. However, the company needs to produce some decent results moving forward, or the street will continue the target cuts we’ve seen. A year ago, the target average was nearly $31, with the average peak coming at $57 in late 2021.

Final thoughts and recommendation:

PagerDuty shares have been one of the market’s worst performers in recent years, and investors are hoping that changes a bit with the upcoming fiscal Q2 report on September 3rd. Expectations call for revenue growth rates to start accelerating again, perhaps being back in the mid-teens over the next couple of quarters. That is still a bit below where things were in the past couple of years, however, a key reason why shares have pulled back.

For now, I have a hold rating on the stock. I need to see that management can deliver some better growth moving forward, and hopefully an improvement in some key metrics as well. Without a solid report, investors may be looking to see if an activist comes in and tries to shake things up, or if Cathie Wood and Ark Invest decide to dump their large stake.