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Why DocuSign Stock Is Flashing Too Many Warning Signals

Like so many software names, DocuSign has a great story ... and an increasingly questionable valuation

As a business, DocuSign (NASDAQ:DOCU) stock looks like one of the better growth names out there. But with DocuSign stock up nearly 50% since a fiscal second quarter beat in early September, the question is whether its potential is priced in.

Why DocuSign Stock Is Flashing Too Many Warning Signals
Source: Sundry Photography / Shutterstock.com

To be sure, that has been a common question in this bull market. There has been no shortage of analysts, writers and investors who called growth stocks “too expensive”. For most of the past decade, those skeptics have been wrong, and too-cautious investors have missed out on big gains as a result.

That said, 2019 has been different on that front. And that suggests some caution toward DocuSign stock at all-time highs.

The Case for DOCU Stock

The case for DOCU stock admittedly is attractive. The e-signature company leads its market, and that market could be huge. E-signature software can replace paperwork across any number of industries.

DocuSign has estimated its addressable market at $25 billion, and said this year that the figure could double as it builds out its offering. With fiscal 2020 (ending January) revenue guided to just under $1 billion, DocuSign clearly has a long runway for growth.

To be sure, DocuSign isn’t cheap. It trades at roughly 12x sales on an enterprise value basis (which includes net debt). Profit margins remain thin: Street consensus for next year’s earnings per share of 40 cents suggests a forward price-to-earnings multiple around 167x.

But neither multiple on its face is necessarily out of line in this market, or for enterprise software names with big opportunities. (Most of DocuSign’s revenue comes from large businesses; small businesses and consumer revenues appear to be less than 15% of total sales.) On a revenue basis, DOCU stock is cheaper than Anaplan (NYSE:PLAN) and trades in line with Q2 Holdings (NYSE:QTWO). QTWO, too, should be barely profitable next year; Anaplan still is running losses.

Given peer valuations and the opportunity, DOCU stock does have the potential to grow into those high multiples. Indeed, Wall Street believes that’s the case: the average price target for DocuSign stock still suggests 8.5% upside from the current price, which sits just short of an all-time high.

Competitive Concerns

That said, there is one significant concern worth watching here: competition. DocuSign does seem to have a head start on the market. But Adobe (NASDAQ:ADBE) is a viable competitor with its EchoSign, and that company can leverage its existing portfolio (notably PDF maker Acrobat) to drive adoption.

Meanwhile, Dropbox (NASDAQ:DBX) has entered the space through its acquisition of HelloSign. That company, too, has an existing base of storage customers to which it can offer its e-signature product.

So far, DocuSign has held off its competition. Revenue should grow at least 35% in fiscal 2020. But as DOCU stock itself has shown, there’s not much room for a stumble of any kind in its valuation. Rising competitive pressure could be a significant downside catalyst for the stock.

Is DocuSign Stock the Next One to Fall?

Again, in this market investors have done well to focus on the growth story and not the valuation. That history would seem to suggest further upside in DocuSign stock, which has a great story and a valuation that is at least reasonable by the standards of tech growth stocks.

That said, 2019 has been different on that front. Repeatedly, the market has shown that valuation does matter. Likely the market’s two best stocks in the first eight months of the year were Shopify (NYSE:SHOP) and Roku (NASDAQ:ROKU). Not coincidentally, both companies had among the best stories in the market, with massive growth opportunities based on long-term secular trends.

Both stocks have pulled back over 25%. Even in the enterprise space, the market’s favorite growth names have weakened. Salesforce (NYSE:CRM) long has been a barometer for growth names and valuations in tech. It has traded sideways for most of the year. ADBE is off July highs. Growth plays Workday (NASDAQ:WDAY) and Splunk (NASDAQ:SPLK) too have pulled back.

Story has been more important than valuation in this bull market. But of late, that rule hasn’t necessarily held. Fundamentals now matter. And that suggests some potential risk to a stock trading at 167x next year’s earnings.

And it’s worth remembering that DOCU stock itself has seen some volatility. Again, the stock has gained almost 50% from pre-earnings levels in a little over two months. Those pre-earnings levels came following a selloff after disappointing first quarter results. And while the stock recouped those losses, it again turned south in late July, amid broader weakness in growth stocks.

This is not to say that DOCU stock is going to plunge. Current valuation in fact looks reasonably fair. But “fair” isn’t necessarily compelling if the market is less forgiving toward valuation than it has been. That certainly seems to be the case. And it, in turn, suggests that most, if not all, of the good news for the DocuSign business is priced into DocuSign stock.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2019/11/docusign-stock-flashing-warning-signals/.

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