Buy ServiceNow Stock?

Service Today‘s (NOW 0.15%) the stock price fell 3% on July 28 following its second quarter report. The cloud-based software company’s adjusted revenue rose 30% year over year to $1.82 billion, beating analysts’ estimates by $60 million. Its adjusted net income grew 15% to $329 million, or $1.62 per share, also beating the consensus estimate by $0.07.

Those headline numbers look solid, but ServiceNow cut its guidance for its core subscription business, which brings in 95% of its revenue in the first half of 2022. For the full year, it expects subscription revenue to increase of about 24%, compared to its previous forecast for 28% growth.

Should investors revisit that reduced guidance and consider ServiceNow’s post-earnings slowdown as a buying opportunity? Let’s examine its growth rates, long-term targets, and valuations to decide.

An evergreen business with room to grow

ServiceNow’s cloud-based services organize unstructured work patterns in a company, then streamline them into intelligent, automated workflows. That process allows companies to reduce costs, optimize their businesses, expand, and modernize their platforms for hybrid and remote workers. About 80% of Fortune 500 companies already use its services.

ServiceNow primarily measures its growth in terms of its subscription revenue and current outstanding performance obligations (cRPO), or the future revenue it expects to generate from its existing contracts over the next 12 months. Both year-on-year growth rates have consistently hovered near 30% in constant currency terms over the past year.

Data source: ServiceNow, same currency terms. YOY = year to year.

That’s why cutting full-year subscription revenue guidance to just 24% growth initially rattled investors. But on closer inspection, it attributed the entire guidance cut to currency headwinds. On a constant currency basis, it still expects to achieve its original target of 28% growth.

It keeps locking in new customers

ServiceNow continues to acquire large customers signing annual contract value (ACV) of more than $1 million, while its renewal rate has remained consistently above 99%.

Data source: ServiceNow, same currency terms. YOY = year to year.

During the company’s second quarter conference call, CFO Gina Mastantuono said that as many of its customers face macroeconomic challenges, they are turning to ServiceNow to “reinvent their business models so they can innovate to win and come out of this moment stronger than ever.”

In other words, ServiceNow is like other evergreen cloud software companies Salesforcewhich also helps large companies digitally streamline their businesses, automate tasks, and reduce costs to combat macroeconomic headwinds.

Rock-solid edges

ServiceNow’s subscription-based gross and operating margins have remained broadly stable over the past year on a non-GAAP (generally accepted accounting principles) basis, suggesting it still has plenty of pricing power and scale to pull through. the near-term headwinds.

Data source: ServiceNow, not GAAP. YOY = year to year.

For the full year, it expects its gross subscription margin to increase by 1 percentage point to 86%. It expects its operating margin to remain flat at 25% as it pares the currency headwind of 1 percentage point with more disciplined spending measures.

But can ServiceNow maintain its premium valuation?

ServiceNow’s growth rates are solid, and it still expects its annual revenue to grow at a compound annual growth rate of at least 22.5% from 2021 to 2026, to over $16 billion in the latter year.

It reaffirmed the forecast, which it raised from $15 billion in May, during the conference call. That confidence probably makes ServiceNow more credible than a growing number of tech companies that have recently scaled back or simply ignored their lofty multi-year goals.

However, ServiceNow’s premium valuation also reflects those strengths. It already trades at more than 60 times forward earnings and 10 times next year’s sales. By comparison, Salesforce — which is larger but growing at a slower clip — trades at less than 40 times forward earnings and just five times next year’s sales. Therefore, ServiceNow stock can be priced for perfection at these levels.

It is a good long-term investment

ServiceNow stock isn’t cheap yet, and its near-term potential may be limited by rising rates and other macro headwinds. However, investors who gradually accumulate shares of this high-quality cloud company will likely be rewarded in the long term as it continues to acquire new customers, expand its ecosystem with new services, grow of its margins, and attracting more attention from the bulls.

Leo Sun has positions in Salesforce, Inc. The Motley Fool has positions in and recommends Salesforce, Inc. and ServiceNow, Inc. The Motley Fool has a disclosure policy.

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