ServiceNow (NYSE:NOW), an enterprise IT company specializing in digital transformation, AI process assistance, data analytics, and cloud migration, has seen significant growth and profitability in recent years. However, investors are questioning whether the stock’s current high valuation is justified.
Over the last 12 months, ServiceNow’s stock has surged over 72%, outperforming many other technology companies. This strong performance raises the question of whether the stock is a good buy at its current price, especially considering the overall expensive nature of the tech sector.
One of ServiceNow’s key products is its Now Intelligence platform, which enables AI automation and helps businesses gain insights from large data pools. This platform has been a driving force behind the company’s success, contributing to its impressive earnings per diluted share of $8.42 and a net profit margin of 19.3% over the past year.
Furthermore, ServiceNow reported impressive growth in its Q4 earnings, with subscription revenue rising by 27% to $2.4 billion. The company also experienced a significant increase in new transactions with a value of $1 million or more, highlighting its strong performance.
While ServiceNow has achieved profitability and demonstrated growth, it’s important to note that this level of success is relatively recent. In 2022, the company generated just $1.60 per share in earnings, and its recent profitability can be attributed to a positive Q2 performance. As a result, ServiceNow has yet to establish a consistent trend of predictable earnings growth.
Despite this, analysts remain optimistic about the company’s future prospects. They project annual earnings growth of around 31% over the next five years. ServiceNow’s management also forecasts continued revenue growth of approximately 24% year-over-year for Q1 of 2024, along with a 31% annual increase in free cash flow.
Another favorable aspect of ServiceNow is its low debt-to-equity ratio of 0.2, indicating manageable debt levels even as the company experiences rapid growth. This sets it apart from many other tech companies that often carry higher debt loads and rely on expectations of future profitability.
However, the stock’s high valuation poses a challenge for potential investors. NOW shares currently trade at around 60 times forward earnings, 99 times cash flow, and 18 times sales. While earnings are expected to grow rapidly in the coming years, the current valuation suggests that the stock’s best-case scenario has already been priced in.
Analysts do not anticipate a stall or downward correction for ServiceNow this year. Their average price forecast implies around a 6% upside from the recent price of $790.39. While there is still room for growth, investors may find limited upside potential in NOW shares given their already high price tag.
In addition to valuation concerns, ServiceNow faces industry-specific risks. It operates in a highly competitive environment with competitors like Datadog, which may challenge its position in the market. There is also speculation that the gains driven by AI enthusiasm in 2023 may create a bubble, potentially leading to a stock market correction in 2024. Investors should be prepared for more realistic views on AI and its value.
Moreover, ServiceNow is susceptible to the risks of a macroeconomic slowdown that could impact spending on digital transformation. Analysts expect IT spending to slightly slow down this year as businesses assess their technology needs. If a recession occurs, IT budgets may be further trimmed, leading to reduced spending in a challenging macro environment.
Despite these risks, ServiceNow remains an attractive company benefiting from increasing investment in AI and cloud computing. Its track record of raising earnings and maintaining low debt levels gives it a degree of financial flexibility. However, potential investors should be cautious of the stock’s already high valuation and closely monitor ServiceNow’s ability to sustain its growth in the future.
