The sell-off in the broad market over the past five weeks has created opportunities for investors to own some of the best growth stocks at a discount. As investors are starting to figure out, Splunk (NASDAQ:SPLK) stock presents one of those opportunities.
After gaining almost 7% during Tuesday’s market-wide rally, SPLK stock now has bounced 29% from its lows earlier this month. To some investors, that might suggest the easy money has been made.
That’s not the case. Splunk stock still sits well below recent highs. It remains a perfect example of the market’s ongoing focus on short-term risks instead of long-term potential.
I don’t want to be cavalier and dismiss the human toll of the coronavirus crisis. But the world, and the economy, will persist, and at some point this crisis will fade. The value of Splunk’s transformative business will not.
The Case for SPLK Stock
I discussed Splunk’s business model at length last month. Splunk is a leader in artificial intelligence. Its platform mines machine data — what Splunk calls the “digital exhaust” of a business — for insights that can drive better decision-making and higher profit.
The applications are almost endless. Splunk’s software can identify service problems that are leading to customer losses. It can detect evidence of fraud, or highlight potential gaps in marketing campaigns.
And Splunk’s capabilities have driven impressive growth. Revenue rose 31% in 2019. This is a company founded only in 2003, which as of this month’s fourth quarter release expected to generate roughly $2.6 billion in sales in 2020.
Outside of some of the best software companies in the world — Salesforce.com (NYSE:CRM) comes to mind — few, if any, firms have been able to drive that kind of revenue less than two decades after their founding.
Earnings Better Than They Look
It’s tempting to look at the decline in SPLK stock over recent weeks and attribute it to fourth quarter earnings on Mar. 4. Results for Q4 were in line. But the company’s outlook for fiscal 2021 (which ends Jan. 31) appeared to be hugely disappointing.
Revenue guidance of $2.6 billion suggests only about 10% revenue growth year-over-year. Wall Street was expecting a 22% increase. Investors initially dumped SPLK stock on the news, believing that the business was decelerating.
But as chief executive officer Doug Merritt explained to Bloomberg, that’s simply not the case. Rather, the company is shifting to cloud-based offerings from license agreements with fixed terms. Revenue from cloud agreements is recognized on a more delayed basis, which pressures the reported top-line figure.
Splunk thus reports ARR (annual recurring revenue), which adjusts for the varying recognition schedules of different contracts. And that figure shows how well the business is performing.
ARR grew 54% in the fourth quarter. And Splunk expects the metric to grow at a 40% annualized rate through the next three years.
That’s one of the best growth rates in the entire market. But at a little over 7x revenue, SPLK stock is not valued as one of the market’s best growth stories.
Buy the Dip
Again, some investors are figuring that out. But there’s little reason why the rally in SPLK has to stop at this point.
As always, there are risks. Competition is intense, with Elastic (NYSE:ESTC) and Datadog (NASDAQ:DDOG) among the better rivals. And SPLK stock looks expensive on an earnings basis: it trades at 81x next year’s consensus earnings per share estimate.
But those risks are worth taking. The market is large enough for multiple winners. (In fact, both ESTC and DDOG look intriguing after their own sell-offs.) And near-term earnings don’t capture the long-term potential. As growth companies should, Splunk is investing now to attract ‘sticky’ long-term customers.
Only a few weeks ago, investors were taking the long view and rewarding the companies that made those investments. But in this panicked time that focus has been lost.
It will return. And when it does, SPLK stock will get back to its winning ways.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.