Shares of data-parsing company Splunk (NASDAQ:SPLK) have more than doubled in the last year and a quarter. Big data isn't new, but many companies are only just beginning to embrace its value. That benefits this technology company, so there is reason to believe it's not too late to get in on the action.
Big data, and how Splunk fits in
Massive quantities of data are constantly being created by web page clicks, applications, servers, and payment processing systems. Most of that data is unorganized and practically unusable, so Splunk developed a system to help businesses change that. Its cloud-based app organizes and analyzes information generated by an organization's devices, apps, sites, and systems, so it can look for trends and other useful items that help the business make better decisions. It also has machine-learning software that uses the newly organized data to make predictions.
Splunk's software also has been put to use in cybersecurity and fraud protection, system failure detection, fleet tracking, and website monitoring. The company has a high rate of retention and has been expanding relationships with current customers, but new ones are quickly being added, too. Over 570 customers were added in the last quarter, bringing the total to over 15,400, which keeps Splunk on track to hit its goal of 20,000 by the year 2020.
All of that has led to big revenue gains, the primary driver of the stock at this point. The company exceeded $1 billion in revenue for the first time last year and is pushing to hit $2 billion by 2020.
It looks like those lofty goals will be met in the next few years. Splunk has momentum, and the amount of data out there is only growing -- there is expected to be 44 times more data produced in 2020 than there was in 2009. With that type of outlook, the stock is "buy" for sure, right?
Valuing an unprofitable tech stock
It's important to acknowledge that Splunk is not yet a profitable enterprise. In 2017, the operating and net losses were $254 million and $259 million, respectively. Though the stock has had a great run the last year, it is historically volatile because of big fluctuations in those bottom-line figures. So investors leery of roller coaster rides should pause before jumping in.
For everyone else, though, Splunk actually reports a profit when adjusting for things like stock-based compensation and amortization. Adjusted earnings were $0.62, a 77% increase over the year prior. That adjusted figure puts its trailing-12-month PE ratio at a pricey 173. While paying for 173 years' worth of adjusted profits is a rich valuation by anyone's measure, things look better when using free cash flow -- money left over after basic operations are paid for, excluding investments back into the business.
Now, paying for 62 years of today's levels of annual free cash flow is still expensive, but Splunk might be worth it over the long term. Cash generated from the business is steadily on the rise as expense and investment growth are slowing, and share-based compensation is also falling. Management expects free cash flow to increase 14% to $275 million this year.
If Splunk can continue delivering double-digit revenue growth and achieve the $2 billion mark in the next two years, those sky-high valuations may not be an issue, as profitability is right around the corner. The company is still relatively small, too, with a valuation of just over $15 billion. Over the longer term, big data will only get bigger, so there's no limit for this company. It could be a bumpy ride, though, so faint-of-heart investors may want to think twice before purchasing shares.