4 Reasons I Just Bought DocuSign Stock

If you've been investing for long, you may have felt this way: "If only I had bought shares of (fill-in-the-blank) stock!"

For me, one of those is DocuSign (DOCU 0.41%), the e-signature technology company with shares I always thought were too expensive. All the while, the stock kept going higher. So when DocuSign recently fell well below its all-time high, I finally bought shares.

Image source: Getty Images.

That purchase wasn't only because DocuSign's price went down. In fact, shares remain expensive by traditional valuation metrics. No, I bought shares because the price went down and because this company resoundingly answers a handful of key questions I had about this investment. Let's take a look.

1. What problem does it solve?

Private and public organizations of all types need agreements signed. For large companies, there could be thousands of those a year. There are expenses in employees' time scheduling meetings, mailing documents, making copies, and filing. All that paperwork can also lead to errors.

That's where DocuSign comes in. The company's electronic signature service makes agreements more efficient, reducing time and the potential for errors. DocuSign's cloud-based software can be used virtually anywhere at any time and can be integrated into hundreds of systems, according to the company. Its flagship eSignature is the main customer draw, but it's part of a platform known as Agreement Cloud. Launched in 2019, Agreement Cloud offers more than a dozen products that help organizations prepare and manage agreements.

2. How big is its market?

The number of agreements handled by small, medium, and large businesses creates an enormous market opportunity. DocuSign estimates a total addressable market of $25 billion for eSignature and believes its Agreement Cloud could add "substantial upside," according to its most recent annual report. Even if those are overly optimistic estimates, with revenue of just over $1 billion in the trailing 12 months, DocuSign has only started to scratch this market's surface.

3. How is the company executing?

DocuSign has a subscription-based service, which means recurring revenue as long as it keeps customers hooked. It also can grow revenue by increasing customer spending. How has it fared?

Customer additions: In the first half of this fiscal year, DocuSign added 166,000 new customers, far exceeding its total added (112,000) for all of the previous year. DocuSign had 749,000 customers through the fiscal second quarter, which ended July 31. The company's customer base has grown 75% from just two years earlier, when it had 429,000. 

Customer spending: Customers are finding value on the platform, which is reflected in two numbers -- net dollar-based retention rate and annual contract values. The company reported a record for net dollar-based retention rate of 120% in the second quarter, which means customers who were on the platform a year ago are spending an average of 20% more this year. In the second quarter, DocuSign had 520 customers with an average annual contract value of greater than $300,000. That's a 41% year-over-year increase.

The company produces only a small profit on an adjusted basis, but it is free-cash-flow positive, producing nearly $100 million in the most recent quarter. That's important because it can be used to fund future growth.

4. Is this growth a result of the pandemic?

While its recent performance was supercharged by the pandemic, DocuSign's annual revenue growth shows the company had been growing fast long before COVID-19. Here's a look:

Data source: DocuSign annual report. Note: Fiscal years end on Jan. 31. Company is currently in FY 2021. * = Analysts' consensus estimate for fiscal year 2021, which ends Jan. 31.

It's possible that growth could slow down in a post-pandemic world. After all, in the early days of the pandemic, many customers came to DocuSign desperately trying to keep their businesses going. But management is optimistic those new customers are seeing the benefits of the platform.

"What we are seeing now is people saying, 'Wow, this is fantastic. There are more places where I could leverage this in my business,'" CEO Dan Springer said during the company's second-quarter earnings call.  

eSignature has been the primary growth driver, but DocuSign has been adding products in its Agreement Cloud, including DocuSign CLM (contract lifecycle management). The product -- a result of a 2018 acquisition -- is intended to help large organizations streamline processes in all stages of the agreement process, from negotiations to document storage. DocuSign CLM was named a leader in Gartner's Magic Quadrant for Contract Lifecycle Management, a positive sign that customers could adopt the product. 

My decision to buy

DOCU data by YCharts

DocuSign's share price has tripled this year, and it reached an all-time closing high of $268.80 on Sept. 1. It soon declined as part of a broader technology stock sell-off. In early November, the stock was trading nearly 30% below its all-time high, and that's when I opened a small position with the intention of periodically adding more -- hopefully at lower prices, but probably higher. (As of this writing, it remains nearly 20% below its all-time high.)

This isn't a stock for the faint of heart. Even after its drop, DocuSign trades at a lofty 34 times sales. With so much optimism already priced in, the shares could get hit hard if DocuSign fails to meet or exceed short-term expectations. However, my planned holding period is years, not quarters. If the company continues adding customers who keep increasing their spending, I will be a happy shareholder for years.