Why ServiceNow Remains a Winner to Buy on Dips

ServiceNow (NYSE:NOW) stock dropped in late July after the digital workflow giant reported second-quarter numbers which topped expectations, as well as guidance pointing to a slowdown in the second half. A slowdown isn’t great news, but it’s not that much of a slowdown. And certainly not enough to alter the long-term growth narrative supporting NOW stock.

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In the big picture, ServiceNow remains a winner in a world struck by the novel coronavirus, wherein the future of the office will involve a hybrid of remote and in-person work.

In that world, digital workflows become ubiquitous across the enterprise landscape, ServiceNow sustains big growth for a lot longer and NOW stock remains on a winning path.

So buy NOW stock on any and all near-term dips.

Here’s a deeper look.

Strong Earnings and Mixed Guidance

ServiceNow’s second quarter earnings were strong.

The number of customers with an average contract value north of $1 million grew by 26% year-over-year. The company closed 40 transactions worth more than $1 million. Subscription revenue rose 32%. Total revenue rose 30%. Subscription gross margins clocked in at 87%. Operating margins expanded 10 points year-over-year to 28%.

Those are all great numbers. And they speak to the fact that, amid widespread physical office closures in the first-half of 2020, enterprises rapidly adopted digital workflow solutions.

Wall Street had some issues with the guidance, however.

Specifically, management’s third-quarter and full-year guides imply that growth is going to slow in the back half of the year.

Third-quarter sub revenues are expected to rise 26.5% (versus 32% in Q2). Full-year sub revenues are expected to rise 29.5%. Operating margins are expected at 22% in Q3, and 24% in 2020.

Broadly, then, management is guiding for both top-line growth and margin expansion to slow in the second half of the year, and that’s largely why NOW stock dropped.

Favorable Long-Term Growth Drivers

In the big picture, this small post-earnings sell-off in NOW stock is nothing more than the stock taking a temporary breather after a red-hot rally.

Why?

Because a slowdown from 32% growth in Q2 to 26% growth in Q2 is nothing to worry about, considering that the future remains very bright for ServiceNow.

Long story short, the days of office centricity are over. We live in a world where the internet is broadly available, where everything is becoming increasingly digital and where cloud-hosted work productivity and communication tools enable employees to to do efficient and productive work from anywhere they want.

In that world, why do we need an office? Morale? Maybe. Social team building? Sure.

There are reasons to have an office in 2020. But those reasons are few and far between, and the rise of remote work is a trend which is here to stick. The future of work will be a hybrid model which comprises, in equal parts, remote work and in-office work.

In that world, digital workflows are mission-critical. ServiceNow is the best when it comes to providing highly scalable and flexible pan-enterprise digital workflow solutions.

To that end, it is quite likely that ServiceNow reaches enterprise ubiquity within the next decade.

The company has just 964 customers with ACV north of $1 million today. There’s ample room for ServiceNow to sustain huge growth for a lot longer.

NOW Stock Valuation Matters

The only reason not to buy NOW stock on dips today is if the valuation were extended.

It’s not.

Relative to the company’s long-term growth prospects, ServiceNow stock remains reasonably valued today.

As digital workflows become ubiquitous and as ServiceNow becomes a mission-critical enterprise tool, the company will sustain 20%-plus customer, contract and revenue growth for at least the next five years, if not longer.

On top of that, ServiceNow runs on a highly scalable, 80%-plus gross margin software business model. Consequently, sustained 20%-plus revenue growth over the next several years will flow into 25%-plus or better profit growth.

Given these favorable growth dynamics, I see ServiceNow’s earnings per share running toward $26 by 2030 (up from $3.32 last year). Based on a 35 times forward earnings multiple – which is the medium-term average multiple for application software stocks – a reasonable 2029 price target for NOW stock is $910.

Discounted back by 8.5% per year, that implies a fair 2020 price target for ServiceNow stock of nearly $440.

Bottom Line on NOW Stock

ServiceNow is a winning company in the hybrid office world of tomorrow, and NOW stock remains reasonably valued relative to the company’s long-term growth potential.

As such, at current levels, NOW stock is a “buy-the-dip” name.

On future big dips, buy the stock, and hold it for the long haul.

Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been recognized as one of the best stock pickers in the world by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm.  As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2020/08/why-servicenow-remains-a-winner-to-buy-on-dips/.

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