When it comes to software-as-a-service businesses (SaaS), few have been more successful Service Today (NOW -1.61%). Its software helps streamline IT workflows across all business segments, creating a seamless interface for employees and customers.
The stock has been strong during its public company life, returning nearly 2,000% from its IPO price. Does the business have enough room to continue growing? Or has it reached its full potential? Let’s dig.
A widely used IT platform
To expand ServiceNow’s offerings, it’s about making IT workflows more efficient. In businesses that use multiple software and hardware products, it’s easy to make mistakes. And when things inevitably go wrong, they’re usually not easy to fix. However, ServiceNow software enables its customers to predict issues and also minimize the impact when things go wrong due to response automation.
ServiceNow’s product is widely used — about 80% of the 500 largest US companies use its product suite. Because of its deep integration within many IT systems and its subscription base, customers are unlikely to ditch ServiceNow due to economic hardship. To support this claim, ServiceNow saw a 99% renewal rate in the second quarter.
However, many investors are concerned about customer acquisition, as ServiceNow (and many of its SaaS siblings) is not a cheap service. However, ServiceNow has performed well in a challenging economic environment.
Solid growth across its subscription plans
In Q2, ServiceNow saw its subscription revenue increase 25% year over year (YOY) to $1.7 billion, and current outstanding performance obligations (RPO, the revenue it expects to generate over the next 12 months from previously signed contracts) increased 21% to $5.75 billion. This is a healthy result from a leading SaaS company, so SaaS investors should not worry about spending on the decline.
However, ServiceNow still cut its full-year sales guidance from 26% to 24% growth. While most of this is due to currency effects, the slight reduction ($33 million) for new business isn’t bad. It shows there are some headwinds, but for the most part, businesses are still spending. Most of this growth is not coming from new customers either. Instead, 85% of new business comes from existing customers, showing how valuable ServiceNow’s tools are and how its expanding product suite is adopted.
ServiceNow also has decent margins, with Q2’s not GAAP (fixed) operating margin reaching 23%. While investors should always be wary of using non-GAAP metrics (due to the reduction of stock-based compensation), if a company is profitable on a GAAP basis, I’m less concerned because it’s not the company tries to hide its unprofitability. Plus, the rest of ServiceNow is up just 17% over five years; that’s a relatively small shareholder cut compared to a 350% stock return.
With a great quarter behind it, investors may be wondering: Is ServiceNow a buy now?
After reviewing the financial results of a business and seeing good signs, it is important to check the valuation, because even the best companies bought at the wrong price can be disastrous investments. However, with ServiceNow trading at 15 times sales, it’s not absurdly overvalued. Its valuation is also relatively close to where it was in 2018, which was the last time the Federal Reserve raised its rates.
With a growing product suite, profitability, and reasonable valuation, I see no reason why ServiceNow isn’t a solid stock to buy. Additionally, its solid quarter gives SaaS investors the green light to continue investing, as companies with key products critical to digital transformation are still seeing growth.
The SaaS space is full of innovative companies with tremendous opportunities, and ServiceNow has established itself as one of the leaders.
Keithen Drury has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends ServiceNow, Inc. The Motley Fool has a disclosure policy.