Updated: Aug 4, 2020
Price on date of analysis: $336.23
Market cap: $64.43B
Overall assessment: STRONG SELL
Target price: $60 (2-3 years)
A quick snapshot: All eyes will be on NOW’s earnings in 2020, and a lot will depend on the level of EPS. Expectations are high, but it is unlikely ServiceNow will be able to deliver results that are anywhere close to the EPS that is fair for its current price. With current PE of 1220 and PEG score of 17, the stock is overpriced by at least 5-6 times as the fair price for the stock is in the most optimistic scenario is $60.
Why did ServiceNow Inc. (NOW) it pique my interest?
Strong growth of share price over the past few years. Gaining as much as 400% in the past 3 years.
Spike in conversations on StockTwits.
Spike in Q4 2019 quarterly earnings.
Interesting products that seem to become more popular.
ServiceNow Inc. (NOW) Overview: company, category description
ServiceNow, Inc. (NOW) engages in the provision of enterprise cloud computing solutions. It offers customer and facilities service management, orchestration core, service mapping, cloud and portfolio management, edge encryption, performance analytics, service portal designer, visual task boards, and configuration management database. The firm offers its solutions for the industries under the categories of Healthcare, Education, Government and Financial Services. The company was founded by Frederic B. Luddy in June 2004 and is headquartered in Santa Clara, CA.
ServiceNow (NOW) stock had an impressive almost 5-times growth over the past few years when it grew from $70 to $338 from April 2016 to this date.
ServiceNow Inc. (NOW) Financial overview
The chart below shows ServiceNow EPS was up and down, hovering around $0 line for the past few quarters. In Q3 2019 it was able to secure a solid profit of 0.22 EPS. In Q4 2019, EPS suddenly shot to $3.03, causing a spike in price. Let’s look closer at the latest EPS results to understand if that is something that is the new NOW EPS forever.
The chart of Revenue and EPS growth up till Q3 2019 shows sales and EPS (with a bit volatility) were growing well over the past 5 years. Sales were growing at 32%-38% every year.
Looking at ServiceNow (Now) income statement for Q4 2019, we notice that strong EPS results in the latest quarter were caused by the one-time income tax benefit from the release of a valuation allowance on the deferred tax assets.
We must remove the tax benefit from the calculations as it distorts the picture with PE ratio, PEG, etc. Removing the tax benefit, we can see that ServiceNow made 34.19M in pre-tax income. This is even lower than in Q3 when the company made $60.77M. Without the tax benefit, the EPS for ServiceNow in Q4 would have been $0.127. The EPS for full 2019 year would have been $0.263.
Sales did not grow that much in Q4 2019, with only a modest 7.44% QOQ growth.
It seems ServiceNow (based on the below) does not have issues with debt as it can service it well.
ServiceNow Inc. (NOW) Key financial ratings/Stock Value
In this section, we will look at growth potential, estimates for growth, and fair company value and stock price. While I use estimates given by analysts, I like to do a check on my own, especially that there are too many different views on next year’s EPS.
First, let’s look at estimates and price targets from analysts The chart below estimates the following EPS for the next few years:
$0.277 – Dec 30, 2019 (based on our recalculated EPS removing the tax benefit).
$0.556 – Dec 30, 2020 (+104%)
$1.210 – Dec 30, 2021 (+118%)
$1.662 – Dec 30, 2022 (+37%)
Here is the exempt from ServiceNow Q4 and full-year 2019 investor presentation:
For full-year 2020, ServiceNow forecast subscription revenue of $4.23 billion, up 30% from a year earlier. We will use this guidance to do our analysis of likely profit for 2020 (interesting to note ServiceNow Inc. management did not provide the guidance for EPS growth).
Using the above guidance, we will calculate the likely profit and EPS for 2020 (below).
A few assumptions that I made:
There is also servicing revenue on top of subscription revenue. In 2019 it was $205M. Over the past years, it grew at 6-9% per year. I used a 9% growth to calculate total revenue for 2020.
Gross Margin was increasing every year, which is a good thing. I assumed it would again increase by 2%.
Assume SG&A expense will be flat (however, in the past years, it was increasing).
Assuming unusual expenses and income, tax benefits to be $0. They were pretty small in previous years anyway.
Tax assumption: 27%
The calculations say that the company is likely going to make $0.40 in EPS for the full 2020 year, which is just a 52% increase vs. 2019.
At a price of $338 and the current level of earnings per share, the company, the PE is 1,220. With calculated above my estimated growth of EPS to $0.40 for 2020 (which is below the average estimates above), this represents only 52% growth in earnings. In this case, PE will be 845.
Given over the past few years, revenue growth was never above 40% with an operating leverage of 1.82 that I calculated above; I don’t see how the company will grow by more than 70%. The PEG (price-to-earnings-to-growth) ratio, in this case, is 17 times in the optimistic scenario and 30 in pessimistic.
If we wait for a year and use a $0.40 EPS estimate, then PE (at current price) will be 845. Even then, the PEG ratio will be 12 in the most optimistic scenario. Usually, a PEG ratio of 1 to 1.2 is considered to be good (the lower the better). When the ratio is below 1, this means the stock is undervalued by investors.
Even if we disregard the earnings (you may think my calculations are not right), let’s look at the Price-To-Sales ratio. The ratio for NOW is 63.61B/3.46B = 18.38. Usually, a good ratio is 1 to 2.
The table below shows the company is overpriced on all ratios:
With current PEG/Price to Sales, the fair price for NOW (afraid to even say it) is $20-30, but no way it can be worth $338. What is going on with the stock market, seriously? :)
Are we saying that NOW numbers compare well with the below examples? (market cap is slightly higher for some, but still). Even if ServiceNow grows sales at 50% per year, it will take it 6 years to reach sales levels of Accenture and 8 years to reach the sales levels of Dell.
Numbers except ratios are in a million dollars.
Even if we give NOW a PEG of 3 like for Accenture, its market capitalization should be at $11.2B, and its stock price should be $60.
ServiceNow Inc. (NOW) Ratings by analysts
It seems stock analysts grossly disagree with my calculations above. They rate is as a strong buy with a target price of $363.72.
Who owns it? Changes in ownership
The stock is popular with institutional investors. They own 94% of the float. There are more new positions than closed. However, among those who bought the stock some time ago, there is a pretty much equal volume of bought and sold shares.
ServiceNow Inc. (NOW) Buzz (StockTwits)
There was quite a lot of buzz about the company with message volume spiking when the latest earnings were announced. Even before the news, the level of interest for the stock was quite strong.
The sentiment for the stock, however, is quite volatile from very bearish 2 weeks ago to mostly bullish recently.
ServiceNow Inc. (NOW) Risks
The main risk for the company is that it is very overpriced. I am not saying the company or its products are bad. It is a great company that grows revenue well year after year. However, the market went completely irrational with ServiceNow (NOW) lifting the price way too high. The company is at PE of 1,200 and PEG of 17 when normal PE is around 20-30 and normal PEG for the category is from 2 to 3 (overall good PEG score is around 1, the lower the better).
The first time the company misses estimates or otherwise sends a less positive signal for the market, the stock price will plummet.
ServiceNow Inc. (NOW) Overall assessment and summary
All eyes will be on NOW’s earnings in 2020, and a lot will depend on the level of EPS. Expectations are high, but it is unlikely ServiceNow will be able to deliver results that are anywhere close to the EPS that is fair for its current price. The stock is overpriced by at least 5-6 times as the fair price for the stock is in the most optimistic scenario is $60.
My rating: Strong Sell
Have an idea about ServiceNow (NOW)? You have a different opinion about this stock? I made an error in assumptions? You have additional information to share? Please leave your comments below.