About a month ago, I wrote a piece on InvestorPlace.com which outlined three reasons to buy the shares of big-data analytics company Splunk (NASDAQ:SPLK) on weakness. Those three reasons were simple. The company’s fundamentals remained favorable, investors’ sentiment towards SPLK was improving, and the technicals of Splunk stock implied that the worst of the selloff was over.
Fast forward a month. Splunk stock has rallied an impressive 8% in the month of September, handily topping the S&P 500’s gain of less than 2%.
Should investors book their profits? Or should investors stick with Splunk stock?
I think there are two main reasons why investors should stick with Splunk stock. One, the fundamentals underlying Splunk stock remain favorable, and should enable the shares to reach $140 over the next few months. Secondly, improving investor sentiment towards SPLK stock should keep bulls in control.
The Fundamentals Indicate That Splunk Stock Can Rise to $140
The fundamentals underlying Splunk stock remain favorable and look poised to enable SPLK to reach $140 over the next few months.
The long-term bull thesis on SPLK stock starts and ends with the data revolution. Long story short, data is the most valuable asset in the world. Companies are increasingly realizing that they can leverage data to sell more products and services, target new types of customers, and create new and better products, among many other things. Consequently, every company is doing all they can to collect all the data they can.
Analyzing all that data can be a tall order. That’s where Splunk comes in. It employs a Data-to-Everything platform that helps enterprises extract valuable insights from their data. According to Gartner, Splunk is the best-in-class at doing this, and has been for a long time. That’s why the company’s revenues have grown at an impressive 40%-plus compounded annual rate since fiscal 2015.
This growth is far from over. The volume of data globally is growing at an exponential rate, meaning the amount of money companies are pouring into big-data analytics is also growing rapidly. According to IDC, the big-data-analytics market is expected to increase at a 13% rate over the next few years.
SPLK only controls about 1% of this market today. But its share of this continuously growing market has been consistently increasing 0.15 to 0.2 percentage points each year.
As a result, SPLK looks poised to continue generating 20%-plus revenue growth for a long time, and its margins have positive catalysts. Consequently, its earnings per share can reach $6 by fiscal 2025. Based on a a 10% discount rate and a forward price-earnings multiple of 35, which is average for application software companies, that equates to a 2020 price target for SPLK stock of over $140.
Improving Sentiment Should Support Continued Strength
Improving sentiment towards Splunk stock should support a strong rebound by the shares over the next few quarters.
There are four major factors that should improve sentiment towards SPLK. First, Splunk just announced a new dynamic pricing scheme for its core Date-to-Everything platform, and multiple analysts have been upbeat about this new pricing method. They say it indicates that Splunk is ahead of the competition and is well-positioned to continue gaining market share.
Second, there have been a few analyst upgrades over the past month. Namely, JPMorgan upgraded Splunk stock to “overweight,” while Rosenblatt started the stock with a “buy” rating. Continued upgrades from Wall Street analysts should help SPLK stock move higher.
Third, a rumor about an acquisition offer was positive for investors’ perception of Splunk stock. Specifically, rumors have been swirling that Cisco (NASDAQ:CSCO) offered well over $7 billion for freshly public data analytics company Datadog (NASDAQ:DDOG). That means Cisco was willing to pay over 25-times trailing sales for Datadog, just to get broader exposure to the data-analytics market. SPLK stock trades at under nine times its sales over the last year. Thus, if an acquisition offer was to come Splunk’s way, it would likely be way above the current value of Splunk stock.
Fourth, the momentum-to-value shift which killed momentum stocks like Splunk in early September, is now over. Momentum stocks have bounced back in mid-to-late September as bond yields have stopped surging higher. As long as bond yields remain in check (i.e. as long as the yield of 10-year Treasuries remain below 2%), demand for momentum stocks should remain high, and SPLK stock should rise with its peers.
The Bottom Line on SPLK Stock
Splunk stock is a long-term winner which just went through a not-that-unusual selloff. Such selloffs of non-cyclical growth stocks are needed to shake out weak hands and to keep their valuation in check. Importantly, as long as such selloffs aren’t accompanied by a change in fundamentals, then they are almost always golden buying opportunities.
That is exactly the situation of Splunk stock today. As a result, its recent weakness is nothing more than a good opportunity for long-term investors to buy the stock.
As of this writing, Luke Lango was long SPLK.