More than a year ago, I thought Okta, Inc. (NASDAQ:OKTA) stock was ready for a reversal in prospects despite a lackluster YTD performance leading up to my article. OKTA, which was trading around $71 back then, reversed as predicted and hit a high of around $110 in March 2024 before losing most of those gains. Last Thursday, in a wild trading session, Okta stock dropped almost 18% after reporting decent earnings that failed to impress the market. Although there is no question about the deceleration of growth that we are seeing, I believe Mr. Market is being too harsh on Okta, which has created an opportunity for long-term-oriented investors to double down on OKTA amid short-term weakness.

The Deceleration Of Growth

Okta is not growing as fast as it did during the pandemic. More on that later, but the company reported decent earnings for the second quarter of Fiscal 2025. Revenue grew 16% YoY to $646 million, aided by subscription growth of 17%. Current remaining performance obligations – deferred revenue and backlog expected to be realized within the next 12 months – also grew 13% YoY to almost $2 billion. Okta turned GAAP profitable for the first time ever, reporting GAAP net income of $29 million, compared to a loss of $111 million a year ago.

The Q2 performance, overall, was solid, but Mr. Market punished the company nonetheless. Before I discuss the reasons why I am going against the grain to invest in OKTA today, let’s try to understand the reasons why Okta stock crashed following the earnings print.

The primary reason behind the deteriorating investor sentiment toward Okta is decelerating growth. From YoY growth of more than 60% in mid-2022, quarterly revenue growth has decelerated to 16% today and the management guided for just 11% growth for the next quarter.

Exhibit 1: Okta’s quarterly revenue growth

There are several reasons behind this growth deceleration.

1. Sluggish economic growth has forced many global corporations to slash IT spending, shrinking the short-term addressable market opportunity for Okta. The high customer concentration on SMBs has exacerbated the macroeconomic impact.
2. Okta’s ongoing transition from an SMB-focused identity security solutions provider to a business focused on large-scale enterprises has created some friction, leading to a loss of revenue.
3. The increasing competition from Microsoft Azure Active Directory.
4. Okta’s focus on profitability.

A closer evaluation of these factors reveals Okta is better positioned than Mr. Market believes to enjoy a growth revival in the foreseeable future.

The Growth Slowdown May Turn A Corner In 2025

In this segment of the analysis, I will discuss the long-term impact of each of the growth limiting factors that I revealed earlier to determine whether an acceleration in growth is on the cards for Okta.

Sluggish economic growth, which has prompted businesses to cut back on IT spending, is likely to be proven a temporary setback for Okta. According to Gartner, global IT spending grew only 3.8% in 2023, but spending is expected to grow 7.5% this year, aided by strong AI spending. The data center systems segment is expected to be the best-performing segment with 24% YoY growth in spending, followed by the software segment, which is expected to see a robust 12.6% growth in spending this year.

With a rate cut fast approaching, I believe global businesses will be in better shape to aggressively invest in IT infrastructure, including advanced identity security solutions. This change in fortunes from a macroeconomic perspective will boost the revenue growth potential of Okta by the end of this year, as small businesses – a key target market for the company – will finally feel comfortable spending on upgrading their security capabilities.

Exhibit 2: Global IT spending forecast

Next, we need to acknowledge that Okta is in a transitory business phase where the company is building the tech stack required to cater to the unique, complex requirements of large-scale enterprise customers. It’s important to note that this focus on enterprise customers requires Okta to develop customized solutions and address the demand for complex identity management requirements. Until Okta figures out a recipe that works well for this customer segment, we are likely to see lackluster revenue growth.

However, for Okta to succeed in the long run, it is imperative to make this transition today. Enterprise customers will bring more stability to Okta’s revenue in the future due to better churn compared to SMBs, which was admitted by CFO Brett Tighe during the earnings call a couple of days ago.

Okta is continuing to make progress with its enterprise product offering, attracting high-value customers. The company ended Q2 with 19,300 total customers, including 4,620 customers with annual contract value exceeding $100,000. Steady growth in high-value customers in the last couple of years points to a future where Okta will emerge as an enterprise-first business.

Exhibit 3: The number of customers with ACV of $100K or more

As a long-term-oriented investor, I believe Okta’s focus on enterprise customers will pay off handsomely in the long run, enabling the company to earn substantial revenue by cross-selling products and developing customized solutions that may lead to high customer stickiness.

As I mentioned earlier, Okta is facing increasing competition, especially from the likes of Microsoft Corporation (MSFT). This is especially true in the enterprise market, so Okta’s expansion into this market segment is likely to intensify competition further. After speaking with several of my colleagues in the software industry, I learned that Okta’s identity management solutions are more vendor-agnostic and are better aligned with the increasing demands of customers in a cloud environment. However, I learned that there are not many reasons to switch from Azure to Okta or vice versa for now, which suggests it is important to win clients aggressively in the enterprise sector to secure long-term competitive advantages. This is exactly what Okta is doing today.

Okta, in addition, believes that it outperforms Azure Active Directory in several ways.

Exhibit 4: Okta vs Microsoft

Overall, I believe Okta is well-prepared for the increasing competition in the enterprise identity security solutions sector, but investors will have to pay close attention to new developments.

Finally, I found that Okta’s strong focus on profitability improvements has contributed to the deceleration in revenue growth as the company has cut costs and slashed investments to focus on sustainable growth. Although this may not satisfy Mr. Market’s insatiable hunger for growth, from a long-term perspective, this makes a lot of sense at a time when the competition is heating up.

By focusing on profitability improvements during this challenging phase, Okta is likely to come out as a stronger, leaner business ready to take on the growth opportunities in the next phase of the economic growth cycle. We are already seeing notable improvements on the profitability front. For instance, Okta’s cash flow from operations reached $86 million in Q2 compared to $53 million in the corresponding quarter the previous year, representing 13% of revenue. Total gross margin also settled at 81.7%, meaningfully higher from the average of around 77.5% seen in FY 2022 and FY 2023.

Overall, I believe the factors that are limiting Okta’s growth today are either short-term challenges or strategic initiatives that may lead to robust long-term growth. Based on this conclusion, I believe the market response to Okta’s earnings is off the mark.

Risks To The Thesis

My bullish stance on Okta is based on the assumption that the company will remain competitive in the enterprise sector. Failure to do so will force me to revise my estimates substantially, so I am keeping a close eye on the competitive landscape. In addition to Microsoft, Okta may face competition from a few other tech giants including cybersecurity firms in the long run, which makes competitive threats the biggest risk facing Okta’s long-term growth potential.

Okta’s vulnerability to security incidents is also a major risk that needs to be closely monitored. In October 2023, Okta stock came under pressure after the company revealed a supply chain attack that resulted in massive reputational damage. This is an ongoing risk of investing in a company like Okta.

Takeaway

Okta stock crashed following the Q2 earnings report, despite the company reporting solid growth and improved profitability. Investor expectations for sky-high growth led to this disappointing stock market performance, and I believe the market is missing the bigger picture where the company is making the right strategic moves to enhance its long-term earnings growth potential at the expense of short-term growth. I expect a turnaround in Okta’s prospects in the next Fiscal year, which makes now a good time to slowly build a long position in OKTA before the trade gets crowded.