ServiceNow Shares Could Be Hurt By the Recession

ServiceNow (NYSE:NOW) stock has a very high valuation. Meanwhile, the company is likely to encounter increased competition, and some sectors of the economy are still struggling. Consequently, I believe that ServiceNow stock could underperform the Nasdaq in the near-term and/or the medium-term.

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ServiceNow specializes in providing tools that automate companies’ information technology (IT) functions. As a result, ServiceNow saves its  customers money.

Still, a number of companies that are being hit hard by the recession and the pandemic could shy away from making expensive, new commitments. That, in turn, could make it harder for ServiceNow to achieve the rapid growth that Wall Street is expecting. Analysts, on average, predict that its revenue will surge 24% in the second quarter. That’s below the 32.6% revenue growth that the company generated in 2019, but it’s still pretty ambitious.

Signs of a Slowdown

ServiceNow has some similarities to Salesforce (NYSE:CRM), which cut its 2020 guidance on May 28. Salesforce predicted that its revenue growth would slow down in Q2 and indicated that its results would come in significantly below analysts’ average expectations.

Salesforce, which I had urged investors to avoid before its results were announced, blamed the novel coronavirus pandemic for its guidance reduction. Since announcing its results, Salesforce stock is down slightly, underperforming the Nasdaq.

There are some similarities and some differences between ServiceNow and Salesforce. Both companies sell software-as-a-service that is supposed to enhance companies’ bottom lines. (ServiceNow also sells platform-as-a-service solutions). And both are large firms that are still a couple of steps below the giant tech names. Finally, both ServiceNow and Salesforce must generate strong growth to justify their very high valuations.

Large-Business Focus Helps ServiceNow Stock

On the other hand, I’m more upbeat on ServiceNow. Salesforce is more leveraged to small businesses, while ServiceNow has focused more on Fortune 500 companies. As I’ve discussed previously, I believe that small businesses are being hit much harder by the current economic downturn than large ones. This is mostly because the sectors that have been most hurt, i.e. the travel and restaurants spaces, tend to have many small businesses. Additionally, larger companies have greater access to the Fed’s assistance.

Meanwhile, it’s probably easier for struggling companies to justify buying ServiceNow’s offerings, which could enable them to lay off IT workers. Salesforce’s products focus on helping sales teams which could be struggling during the Covid-19 pandemic.

Meanwhile, two research firms have issued fairly bearish notes on ServiceNow stock in recent weeks.

Specifically, on June 22, Cleveland Research warned that ServiceNow’s partners had indicated that “larger deals” were being delayed until Q3, while ServiceNow’s customers were not  buying as many additional products from it. The firm added that its estimates for ServiceNow’s Q1 results were in line with analysts’ average estimates than previously.

And, after ServiceNow reported its Q1 results on April 29, Piper Sandler downgraded the shares to “neutral” from “overweight,” citing valuation. The firm set a $360 price target on the shares, versus the stock’s current price of about $419.

Competition and Valuation

A Seeking Alpha columnist recently noted that, in order to meet Wall Street’s growth expectations, ServiceNow will have to enter new vertical markets and take market share from some pretty heavy hitters. Among ServiceNow’s new competitors are Salesforce, SAP (NYSE:SAP), Splunk (NASDAQ:SPLK), IBM (NYSE:IBM) and VMware (NYSE:VMW), the columnist stated.

Further, due to the disappearance of some companies and the financial cutbacks of others, prices for ServiceNow’s older and newer products could come down meaningfully going forward.

Finally, ServiceNow stock was trading at a trailing price-sales ratio of about 22, making it quite expensive.

The Bottom Line on ServiceNow Stock

Due to the recession, ServiceNow’s growth could easily slow below analysts’ average expectations, causing its expensive stock to underperform the Nasdaq.

As a result, investors are better off owning other names at this point.

Larry has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been airline stocks, oil stocks and Snap. You can reach him on StockTwits at @larryramer. As of this writing, he did not own any of the aforementioned stocks. 

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