On March 1st, Splunk Inc (NASDAQ:SPLK) beat on fourth-quarter earnings and revenue expectations. Since the report, SPLK stock is up more than 15%. For the year, it’s already up a whopping 30%. With that in mind, and with positive Splunk news seemingly everywhere, is it time to take profits or buy more?
If you ask the analysts, there may be more upside left.
Over the last few weeks, there has been a number of price target increases. The highest now sits at $123 from Needham’s Jack Andrews. Andrews’ target implies about 14% upside. However, a number of other targets poured in too, with many sitting between $115 and $120-per-share.
Based on the Splunk stock analysis from these analysts, many see the company’s momentum continuing. The robust billings growth from the latest quarter should continue throughout 2018. Andrews points out that the company saw a 21% increase in orders over $100,000, while the average selling price for the company’s typical license sale rose to $95,000 from $69,000 in the same period a year ago.
Argus analyst Joseph Bonner makes the case that SPLK stock trades “at a 13% discount to the enterprise value to revenue multiple average of its peers.”
Valuing Splunk Stock
While some analysts may tout Splunk stock as being cheap compared to its peers, it’s not cheap by traditional standards. When a company continually dumps a bulk of its gross profit into growing the business, it’s hard to get a feel for how much it’s worth. In that sense, it’s like Amazon.com, Inc. (NASDAQ:AMZN) in its younger days.
So what’s the deal with Splunk? For the year, Splunk generated $1.27 billion in sales, a 33.7% increase from 2016. The sales growth wasn’t the impressive part though, it’s the company’s gross profit of $1.01 billion. This equals out to gross margins of ~80%. A further breakdown of Splunk shows just what happens as that money filters through its income statement down to the bottom line. Because somehow, the company ends each year with a net loss. How can this be?
Almost 80% of its gross profit is expensed to marketing and sales costs. In other words, For every $100 Splunk makes, it retains $80 of it. It then spends $64 (80%) of that $80 on marketing and sales initiatives to drive more revenue into its channel. Now left with just $16 out of every $100 in total sales, there’s not much left to go around for other costs. In that sense, it’s easy to see why it doesn’t have a positive bottom line.
That’s not always bad though, because we know the company can generate a profit if it simply lowered some of this spending. But why do that when management can continue to grab market share and gain customers with recurring billing?
Trading SPLK Stock
There’s no reason to lower its current growth rate and thus hinder its future profit potential simply to show a more robust bottom line right now. That’s why investors continue to bid up SPLK stock. Of course, some investors will see a $15 billion market cap company with only $1.27 billion in sales and say, “no way!”
But there are a lot of positives here. Guidance for next quarter and the full year came in ahead of expectations. Additionally, both operating cash flow and free cash flow continue to soar. At $200 million a year ago, free cash flow now sits at $263 million for the last year of business. Operating cash flow has grown even more impressively, now at $242 million and up from just over $150 million 12 months ago.
In short, momentum with the business is strong … and so is the stock price.
Splunk stock recently took out its all-time trading high (blue line), as well as its all-time weekly closing high (black line). Because we’re using a five-year weekly chart, the 50-day moving average is not shown. However, that mark currently sits at $94.
I would love for a pullback down to this level. The 50-day will likely act as support, while the $90 to $95 level should be strong support as well. Further, momentum could soon wane as the stock is looking overbought in the short-term (blue circles).
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, he did not hold a position in any of the aforementioned securities.
