Software-as-a-Service (SaaS) stocks started the week by tumbling. As of mid-day Monday, a basket of SaaS stocks had declined by more than 4%.
Splunk (NASDAQ:SPLK), an SaaS provider, wasn’t immune to the selling, as SPLK stock fell 5% on the day. Another leading cloud-computing company, Workday (NASDAQ:WDAY),fell 5% as well, while SaaS company ServiceNow (NYSE:NOW) retreated 2.7%.
This turn in sector sentiment came at a terrible time for SPLK stock. Just last week, SPLK beat analysts’ earnings expectations and raised its guidance for the full year. Its numbers looked amazing. And yet, Splunk stock traded essentially flat following its earnings and fell sharply to start the week. Is it time to buy the dip in Splunk stock yet, or would it be prudent to let SPLK stock continue to correct?
Splunk’s Great Growth Story Continues
Splunk has been one of the most consistent and impressive large-cap tech growth companies in recent memory. Its numbers are truly mind-blowing. Over the past five years, SPLK’s average compounded annual revenue growth rate was 45%. In 2014, the company produced just $451 million of revenue. For the most recent 12 months, that figure quadrupled to more than $1.8 billion of sales.
Additionally, while SPLK has not been very profitable yet, analysts see the tipping point coming soon. On average, analysts forecast that the company’s earnings per share will reach $1.62 over the next year, and its earnings are expected to grow at an average annual rate of more than 30% over the next five years.
Perhaps most incredibly, even as Splunk’s revenues have gone through the roof, its growth rate hasn’t slowed down. Normally, companies decelerate as they get bigger, but Splunk is still finding plenty of opportunities to grow. It’s far more impressive when a company with $1.8 billion of revenue is growing its top line 40% each year than when a firm with a few hundred million dollars of annual revenue is accomplishing the same feat.
Analysts Weigh In
Splunk’s earnings report drew nearly universal praise from analysts. Jeffries, which has long been a Splunk bull, raised its price target on SPLK stock from $137 to $157 following the earnings release. The firm suggested that Splunk is even stronger than it may seem. Wells Fargo, not to be outdone, lifted its price target on SPLK by $20 to $165 per share.
Mark Moerdler of Bernstein raised his price target from $119 to $131. He left a “neutral” rating on the shares. In a moment of humility, he noted that “we obviously got off the bus too early on this one.” Even Citigroup, which is sticking with its “sell” call on SPLK stock, had to give credit where it was due. Citi recommended selling Splunk stock last year as it felt that the company probably wouldn’t grow much more. After Splunk’s recent results, however, Citigroup raised its price target on SPLK stock from $98 to $112.
SPLK Is Still Fairly Expensive
The key issue facing SPLK stock is that Wall Street is fully aware of its great growth outlook. As a result, SPLK stock was trading around 13 times its sales following its most recent earnings report. That’s really pricey, even for a company with phenomenal sales growth. Traditionally, as a rule of thumb, investors need to be careful about paying more than ten times sales for even the fastest-growing tech companies.
Often, when a company reports stellar earnings results and the stock doesn’t move, it is simply because the Street’s expectations were high before the results were released.
If SPLK’s earnings had come in below expectations, it probably would have plunged 10% or more, as investors were really confident that Splunk would continue to grow rapidly. With the market already pricing in greatness, it is hard for Splunk to surprise to the upside, even with outstanding results.
If SPLK stock trades at ten times its sales, and its 2019 sales meet expectations, SPLK stock will rise to nearly $150, considerably higher than today’s price.
Thus, for a patient investor, the selloff of Splunk stock following its great earnings could be a golden opportunity. As long as the company maintains its stunning sales growth, SPLK stock will rise much higher over time. SPLK stock may not rally in the short-term, given macro headwinds, but the value of SPLK will keep increasing, along with the company’s booming revenue forecasts.
At the time of this writing, Ian Bezek held no position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.