DocuSign Stock Is Doomed to Trade Sideways for the Foreseeable Future

DocuSign stock is somewhere between fully valued and overvalued

My thesis on e-signature pioneer DocuSign (NASDAQ:DOCU) stock is pretty simple, and it ultimately boils down to the fact that while DocuSign is a great company, DocuSign stock is fully valued, and this full valuation will ultimately limit how much higher the stock will go in the near- to medium-term.

DocuSign Stock Is Doomed to Trade Sideways for the Foreseeable Future
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At this point, bulls who have made big money on the stock (shares are up 70% over the past year) will tell me that I don’t get it. They’ll argue that big growth stocks deserve big growth valuations. Over time, DocuSign will grow into its valuation, and as it does, the stock will keep grinding higher.

I get all of that.

But, I also get that valuation matters, and right now the valuation simply does not add up. I’m not saying DocuSign is expensive because of its 300-times forward earnings multiple. That cursory analysis is short-sighted. Instead, I’m saying that DocuSign is expensive because, even when you make aggressive assumptions about what this company can grow to in a decade, those aggressive assumptions still don’t support a $70 price tag today.

As such, while low rates and sustained momentum may push shares slightly higher in 2020, I think there are much better growth stocks to buy for the next few months.

DocuSign Is a Great Company

To avoid any and all confusion, let’s get one thing clear: DocuSign is a great company, and excluding valuation, there’s a lot to like about DOCU stock.

DocuSign is number one in the game of digitizing and automating the contract process. That’s a pretty big deal. Everything is going digital these days, including important documents and agreements.

The contract process needs to keep up with the times. Thus, as the corporate world becomes increasingly digital, corporations are increasingly digitizing and automating their contract processes. Importantly, these corporations are turning to DocuSign to do that, because no one else in the marketplace does as good a job of this as they do.

This trend isn’t going to reverse course anytime soon. DocuSign only has 70,000 enterprise and commercial customers. My numbers indicate that over 3 million businesses in DocuSign’s addressable markets could use the company’s service. Thus, this company truly is in the first inning of a multi-year growth narrative wherein companies increasingly digitize the contract process.

At the same time, DocuSign employs a low-cost, software-based business model with sky-high gross margins (around 80%). That leaves ample room for sustained huge revenue growth to drive positive operating leverage and result in huge big profits at scale.

As go profits, so go stocks. Consequently, it reasons that as DocuSign’s profits go from next-to-nothing today to huge in 10 years, DOCU stock will move higher.

DocuSign Stock Is Fully Valued

The one problem with the aforementioned bull thesis? It doesn’t take into account valuation. Once you take into account that very important element, it becomes clear that further upside is limited.

The big problem with DocuSign’s valuation is that it doesn’t incorporate the reality that the company won’t run in open fields forever. That is, this marketplace already has a ton of players, including the formidable Adobe (NASDAQ:ADBE), and as it gets bigger, it’s quite likely that mega-tech giants like Alphabet (NASDAQ:GOOG) and Amazon (NASDAQ:AMZN) develop services which heavily overlap with DocuSign’s services.

As DocuSign gets bigger, it will more aggressively rub elbows with these competitors. That means two things. First, big growth rates will be harder to come by the bigger DocuSign gets. Two, the company will likely have to spend big on marketing and product development in order to sustain big revenue growth in the face of big competition.

Going forward, then, DocuSign’s revenue growth trajectory will naturally slow, while margin expansion will be limited by extensive marketing spend.

Under those assumptions, my modeling suggests that $5 in earnings per share is doable for DocuSign by 2030. That’s up from a mere 24 cents projected for this year. Still, that huge growth from 24 cents to $5 isn’t enough growth to warrant today’s price tag.

Based on a forward price-earnings multiple of 35, which is average for application software firms, and a 10% annual discount rate, $5 in 2030 profits per share implies a 2019 price target of below $70.

Bottom Line on DocuSign Stock

DocuSign is a great company, and sustained operational momentum will likely push shares higher in 2020. But, the magnitude of those gains will be limited by the fact that the stock is already fully valued.

As such, while I like DOCU stock for the long haul, I think there are better growth stocks to buy here and now.

As of this writing, Luke Lango was long ADBE.


Article printed from InvestorPlace Media, https://investorplace.com/2020/01/docusign-stock-trade-sideways-foreseeable-future/.

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