The core argument for many growth stocks comes down to ‘story’ versus valuation, and AppFolio (NASDAQ:APPF) is no exception. AppFolio’s software serves property management companies, with a smaller business for its MyCase legal software. And so far, the story has outweighed any valuation concerns, with AppFolio stock up 90% over the past year and ~70% just since early April.

The optimism makes some sense. Growth has been impressive, with revenue rising by a factor of 14x over six years. Margins are improving as the business leverages sales and marketing spending. And AppFolio plans to move into new markets, creating new revenue and profit streams going forward.

But valuation has become a real question mark. AppFolio now trades for over 12x the high end of 2018 revenue guidance, even backing out a small amount of cash on the books. That multiple has doubled in the past 15 months. Forward P/E is about 60x. Even in a SaaS space full of dear valuations, AppFolio stock seems to stand out.

Ahead of Q2 earnings next week, it’s fair to wonder whether the run might have gone too far. At the very least, AppFolio is going to have to post a monster quarter to keep AppFolio from giving back at least some of its recent gains.

The AppFolio Stock Growth Story

Fundamentally, AppFolio’s growth is impressive. Revenue was under $13 million in 2012; it’s guided to roughly $180 million in 2012. The top line rose 36% last year and should increase 26-27% in 2018. And AppFolio is both profitable and cash flow-positive, with earnings growth expected in the 65-70% range in 2018.

The growth isn’t likely to end any time soon. In the core property management end market (still over 90% of revenue), there are several drivers going forward.

AppFolio can pick up more customers. Existing customers can add more units; in fact, customers added an average of 20% to their portfolios in Q1, per the Q1 conference call. And AppFolio continues to roll out new features.

Most recently, the company added the ability for tenants to purchase rental insurance through AppFolio’s cloud software, with the company taking a commission on the sale.

So AppFolio’s recent trend should continue. As revenue grows, gross margin should expand, and already rose 390 bps in 2017. Sales and marketing spend will be leveraged as its increases lag those of revenue.

There’s a good growth story here – and it’s one to which the market has caught on. Volume has soared from early 2017 levels, and not coincidentally APPF stock has risen over 150%. It seems a dangerous trade to bet against the trend here.

The AppFolio Stock Valuation Question

Still, it’s fair to wonder exactly how much growth is left. There’s a good amount of competition in the space, including publicly traded RealPage (NASDAQ:RP) and privately held Buildium.

Overall demand continues to rise as operators transition from legacy platforms (many simply used Excel, from Microsoft (NASDAQ:MSFT)), but that tailwind will moderate over time.

Growth is probably going to slow – but AppFolio stock hardly seems priced for any type of deceleration. As noted above, APPF trades at a whopping 12x revenue. RP stock trades at a bit under 7x on an EV/revenue basis and about 37x forward earnings against APPF’s 60x.

AppFolio has outgrown RealPage of late but in part due to having a smaller revenue basis. RealPage grew sales 32% in Q1, meanwhile, a faster rate than that of AppFolio.

Even looking at the software space as a whole, AppFolio’s valuation looks stretched.

There are software plays getting higher multiples, admittedly. But those stocks, like Twilio (NYSE:TWLO), Adobe Systems (NASDAQ:ADBE), and Paycom Software (NYSE:PAYC), aren’t single-industry (or dual-industry) plays. Their products target customers across multiple (if not all) industries.

As such, their addressable markets are much larger than that of AppFolio, who really can only sell to property managers and lawyers – with the legal business being a much lower-revenue opportunity. And so it’s fair to wonder why AppFolio stock should be priced near those faster-growing peers, if it eventually will have a ceiling on its growth.

Horizontal Versus Vertical

The bull case for AppFolio is that the ceiling is only temporary. AppFolio is executing what is known as a “vertical” strategy. By targeting a single industry, AppFolio can tailor its software for customers.

Sales and marketing costs are lower, since those salespeople don’t need to cover all businesses, just a tiny fraction of them. Then, once the business is established, the software developed, and profitability ensured, the company can move to adjacent markets.

The model here is Veeva Systems (NYSE:VEEV). Veeva started with a software for life sciences companies aiding in drug development and other technical processes. It’s now expanding into other industries where quality assurance and regulatory standards are paramount. And AppFolio similarly intends to market beyond its core property management customer base.

For Veeva, the strategy has been an unquestioned success. VEEV stock has quadrupled since early 2016, after shorts (myself included) questioned the strategy in the first half of the decade. For AppFolio, however, I’m a bit more skeptical.

First, there aren’t necessarily obvious adjacent markets for its property management software. Veeva’s move from pharmaceutical companies to, say, chemical companies makes sense in that there are obvious parallels in the manufacturing process. I’m not sure those easy markets are there for AppFolio.

Secondly, VEEV was much cheaper when it began its run: its EV/revenue multiple was about half that of AppFolio stock. And so even if AppFolio’s strategy works to the same extent, the potential upside should be lower from this point. That’s a big ‘if’.

All told, it looks like something close to perfection is priced into AppFolio stock. But in this market, and in SaaS in particular, it’s important to remember that a lot of skeptics have looked foolish in making the same argument.

As of this writing, Vince Martin has no positions in any securities mentioned.