Why PagerDuty Stock Just Crashed

Automated response software company PagerDuty (NYSE: PD) stock crashed 25.7% through 11:40 a.m. ET Wednesday after reporting mixed results in its Q3 earnings report last night.

Analysts forecast PagerDuty would earn only $0.24 per share, adjusted for one-time items, and PagerDuty blew out the box on that one, reporting a $0.33 per share profit instead. The software company missed slightly on sales, however, reporting $124.5 million, where Wall Street wanted to see $124.9 million.

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PagerDuty Q3 earnings

Sales climbed 5% year over year, and PagerDuty reported its "second consecutive quarter of GAAP profitability," said CEO Jennifer Tejada, with an operating profit margin of 6.5% and $1.69 per share in earnings as calculated according to generally accepted accounting principles (GAAP) -- yes, you read that right. PagerDuty's GAAP earnings were actually several times better than its non-GAAP adjusted number, which itself beat earnings.

Actual free cash flow, however, was only $20.9 million for the quarter, much less than reported net income of $161.6 million.

Is PagerDuty stock a sell?

If you're going to be conservative, therefore, you should probably value PagerDuty not on its earnings, but on its free cash flow -- its real cash profit. So far this year, that number works out to $117.6 million (versus more than $152 million in reported GAAP profit). The good news is that, based on PagerDuty's current market capitalization of $1.04 billion, this works out to a price-to-free cash flow ratio of only 8.8x.

Even with a modest projected growth rate of only 9%, to me, that seems a fair price to pay for PagerDuty stock. While everyone else on Wall Street today seems to be selling it, I'm going to go ahead and call PagerDuty stock a small-cap buy.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.