Investors who took just a cursory glance at Splunk (NASDAQ:SPLK) likely would move on in a hurry. Splunk is coming off a fiscal first quarter where revenue growth was minimal. The company guided for a loss in Q2. And at 140x forward earnings, Splunk stock is hardly cheap.
But I believe that take would be wrong — for two reasons.
First, simply looking at a few fundamental metrics isn’t sufficient due diligence. It certainly wasn’t a way to make money in the bull market that ended in February. It has hardly been a winning strategy amid the market’s V-shaped recovery, either.
High price-to-earnings multiples, in particular, sometimes are a sign of overvaluation. But for a company like Splunk, elevated P/E ratios often are a sign of a company investing in its business ahead of a big long-term opportunity. Amazon (NASDAQ:AMZN), which has been called “too expensive” for about two decades now, is one of the best examples. There are many, many, more.
It can be easy to forget, but investors in the market are buying a business, not just a stock. A few metrics don’t always show the strength of that business.
Second, Splunk’s numbers are being impacted by the company’s shift to the cloud. This essentially is just an accounting issue. But it has the effect of obscuring strong underlying performance.
Taking a closer look, the case for Splunk stock becomes evident — and attractive. I recommended buying Splunk’s stock near the bottom in March, and even with a snapback rally leaving shares near the highs, I still think there’s more upside left for long-term investors.
Understanding Splunk’s Earnings
Again, Splunk’s Q1 report looks unimpressive, to say the least.
Revenue increased just 2% year-over-year, which hardly sounds like the performance expected of a growth stock. Guidance for the second quarter suggests top-line growth of less than 1%.
Profit numbers look worse. Splunk’s operating loss, even on an adjusted basis, expanded to $111 million in Q1 from just $8 million the year before. The Q2 outlook is better, but not great: its operating loss is expected to come in around $60 million.
This looks like the kind of performance that should send a stock tumbling. Yet Splunk stock rose 13% the day after earnings last month.
But investors need to understand the impact of the company’s transition to the cloud. Instead of selling software licenses, where revenue is recognized upfront, Splunk is moving investors to recurring cloud-based billing.
That shift hits revenue and profits, as Splunk CEO Doug Merritt explained. But it’s essentially just an accounting issue. Splunk still is closing more and larger deals with more and larger customers, winning the likes of Shopify (NYSE:SHOP) and Take-Two Interactive (NASDAQ:TTWO) in the first quarter. Some of the revenue from those deals, however, is being recognized in later years.
Adjusting for that shift, Splunk still is growing like gangbusters. Annualized recurring revenue (ARR) increased 52% year-over-year in Q1. Cloud now drives almost 50% of bookings and is growing at a rate over 80%.
As for operating losses, there’s a simple explanation. Splunk is spending big on sales and marketing. All of the company’s gross profit in the first quarter, and a bit more, went to that line.
That makes sense. Splunk has a massive opportunity. Customers acquired now will contribute high-margin revenue for years to come. Splunk, wisely, is focusing on long-term profits over near-term earnings.
The Big Data Case for Splunk Stock
Of course, that strategy only works if customers acquired now truly will stick around for years, and perhaps decades. The good news for Splunk stock is that I believe they will.
Put simply, Splunk is one of the best “Big Data” plays out there. Its business analytics offering, importantly, creates actionable insights for companies to understand why marketing campaigns are working (or not) or how to improve customer service.
Quite literally, Splunk’s platforms makes sense of data that humans simply don’t have the ability to analyze. As I’ve written before, it’s akin to the advancements made by IBM (NYSE:IBM) in creating digital chess player Deep Blue.
Once customers have access to that knowledge, there’s simply no going back. And with megatrends like 5G wireless and artificial intelligence driving increasingly massive amounts of data, the value of Splunk’s platform will only increase.
Customers know that. That’s why Splunk is posting explosive growth — even if accounting standards mean that growth isn’t showing up in this year’s results. That growth, over time, will drive huge profits and cash flow. That in turn will make Splunk stock a long-term winner.
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.