Workday (WDAY -0.66%) stock has been struggling -- losing around 20% of its value since early July up until now. After that steep decline back to levels last seen in January, investors may wonder if now is a good time to pick up stock in the software vendor, which provides solutions for both financial and human capital management -- or whether its shares could be headed even lower.
Why has Workday been falling?
Shares of Workday performed well for much of the year until the later part of July, which is when investors started to turn bearish on it. It was neither a big earnings miss nor a piece of company-specific news that initially spooked investors; rather, the sell-off looks to have begun with just a bad day in the markets during which a lot of selling took place. Days later, tech stocks came under fire again as President Trump announced new tariffs on Chinese imports. While Workday doesn't have operations in China and shouldn't have much direct exposure to the trade war, its customers could be adversely impacted, so there's potential for the company to be affected indirectly, especially if customers reduce their spending.
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However, since those declines in late July and early August, Workday's share price has continued to fall. One possible explanation may be that investors have scaled back what they are willing to pay for tech companies -- especially ones like Workday that are generating losses -- amid concerns that a recession is on the way.
The problem is that knowing exactly when Workday will be profitable is difficult to gauge at this point, with the company accumulating $495 million in losses over the trailing twelve months. Even as sales have been rising, that hasn't translated into profits for the company as operating expenses have continued to increase right along with revenues.
Recent results have been promising
Workday is coming off a strong second quarter in which sales rose by 32% year over year, from $671.7 million to $887.8 million. Meanwhile, its bottom line has become worse, growing from a loss of $86.2 million a year ago to $120.7 million. The good news is that there's definitely a lot of excitement around the business, especially given the significant number of Fortune 500 companies that use Workday's software. It's seeing heavy demand for its services, and its top-line growth is expected to continue apace. Workday's focus on automation and improving business operations could be more important than ever, especially if a recession were to hit. By increasing efficiency and reducing overhead, companies can become more competitive, and that's where Workday can add a lot of value.
And with the company consistently generating positive cash flow from its operations, those net losses shouldn't weigh too heavily on the minds of investors. With $674 million of cash generated over the past four quarters from its day-to-day operations, Workday still looks to be in a strong financial position. In each of the past four straight quarters, Workday's cash flow from operating activities has been at least $100 million. If it can continue that trend, the company will have a lot of flexibility moving forward.
Key takeaways for investors
Lately, the share prices of growth stocks have been falling, and Workday has taken part in that decline. Although the company has been doing all the right things and its business is expanding, there is, unfortunately, still plenty of room for its share price to slide further, especially if negativity continues to pervade the broader market.
When in doubt about the outlook for a stock, it can be useful to look at its valuation ratios to see whether more of a correction could reasonably take place. In the case of Workday, its price-to-sales ratio of over 11 and price-to-book multiple of 17 reveal ample room for the stock to drop to more conventional valuations. Even its price-earnings-to-growth ratio, which factors in its expected growth rate, sits at well over 3.0. A PEG ratio higher than 1 suggests a stock is overvalued -- a 3 indicates that Workday's growth outlook is insufficient to justify its share price.
Workday is a promising software company, and the stock could be a good addition to many investors' watch lists, but until there's evidence to suggest that it has reached a bottom, it could be too risky to buy at present.
