Big data software provider Splunk (NASDAQ:SPLK) has been on a tear. Company stock has doubled since 2017 as more and more enterprises decide it's time to do something with the raw data they have. Considering the massive growth in digital information being created every year -- a phenomenon which Splunk maintains is expected to expand at a double-digit annual rate for the foreseeable future -- this software company may have plenty of good years left ahead of it.

Demystifying mass information

Splunk's services help enterprises make sense of data being created by web pages, apps, and other digital systems. Much of the data being generated by both new and legacy systems doesn't get organized very well. Splunk changes that, helping organizations turn its previously unusable information into "aha moments" they can use to improve operations, get insight on customers, and prevent malicious activity.

Numerable use cases for Splunk's machine data software have been found, including a recent push into the world of artificial intelligence (AI) and cybersecurity. Splunk went on a shopping spree in the last year, acquiring several complementary businesses to bolster its abilities to fight cybercrime. At the end of the company's fiscal first quarter of 2019 (three months ended Apr. 30, 2018), it was nearing 16,000 total customers, and it's pushing for 20,000 customers and $2 billion in annual revenue by the year 2020.

A man in a suit holds a tablet. Above the screen is a hologram of a brain illustrated with electrical connections depicting artificial intelligence.

Image source: Getty Images.

Where is Splunk now?

The company breaks its revenues into two segments: "license" and "maintenance and services." Both are growing in the double digits, but the licensing segment -- which comprises mostly software as a service (SaaS) that generates recurring revenue from subscription fees -- is the more important of the two. Not only is its income more predictable, it also carries a much higher profit margin. Management stated that total software revenues increased 43% year over year to kick off 2018:

Metric

Q1 2018

Q1 2017

Increase (YOY)

Licensing revenue

$139.0 million

$102.6 million

35.5%

Licensing gross profit margin

96.3%

97.1%

(0.8 p.p)

Maintenance and services revenue

$172.7 million

$124.2 million

39.0%

Maintenance and services gross profit margin

57.8%

55.6%

2.2 p.p.

Data source: Splunk quarterly earnings. P.p. = percentage points.

The viability of Splunk's services is solid, yet the company still reports an operating loss every quarter. That's because of high operating expenses in the service of pushing total sales higher. For example, in the first quarter of 2018, Splunk spent $218.0 million on sales and marketing and $86.4 million on research and development. As a result, the company's operating loss was $121.5 million.

Inching toward profitability

Given the amount of money being dumped into the sales engine at Splunk, some context is needed to assess the stock. Splunk's earnings reports do some of the legwork for us by providing supplemental adjusted operating results that back out stock-based compensation and the amortization of intangible assets. When accounting for those items, the first quarter operating loss narrows to only $18.0 million. That's an operating loss margin of 7.9%, but management said it expects that adjusted margin to swing to a profit during the last two quarters of 2018.

Things look even better when using free cash flow, or cash provided by adjusted operations less capital expenditures. By that measure, Splunk has been in positive territory for quite some time and continues to produce even more free cash flow every quarter.

SPLK Free Cash Flow (TTM) Chart

Data by YCharts.

Using price-to-free cash flow instead of the more common price-to-earnings metric (since the company runs at a net loss, price-to-earnings readings are problematic) yields a ratio of 52.0. That's a rich price tag, but the number has been getting smaller over time as the company expands and funnels less money as a percentage of revenue into expansion efforts.

Thus, Splunk is investing heavily in itself now for a bigger payoff later on. The stock isn't for everyone, though, as even small changes in revenue and expense growth can cause shares to make some wild moves. Even so, annual sales have increased more than 500% since Splunk went public back in 2012, and the company is knocking on the door to profitability. Considering this, and the continued steep increase in digital data around the world, Splunk is a buy for those interested in holding on for the long haul.

Nicholas Rossolillo and his clients own shares of Splunk. The Motley Fool owns shares of and recommends Splunk. The Motley Fool has a disclosure policy.