Is ServiceNow Stock a Buy Now?

ServiceNow's (NOW 2.63%) stock price dipped 3% on July 28 following its second-quarter report. The cloud-based software company's adjusted revenue rose 30% year over year to $1.82 billion, which beat analysts' estimates by $60 million. Its adjusted net income grew 15% to $329 million, or $1.62 per share, which also beat the consensus forecast by $0.07.

Those headline numbers look solid, but ServiceNow reduced its guidance for the core subscription business, which brought in 95% of its revenue in the first half of 2022. For the full year, it expects its subscription revenue to increase about 24%, compared to its previous forecast for 28% growth.

Image source: Getty Images.

Should investors look past that reduced guidance and consider ServiceNow's post-earnings dip to be a buying opportunity? Let's review its growth rates, long-term targets, and valuations to decide.

An evergreen business with room to grow

ServiceNow's cloud-based services organize unstructured work patterns across a company, then streamline them into intelligent and automated workflows. That process enables companies to cut costs, optimize their businesses, expand, and modernize their platforms for hybrid and remote workers. Approximately 80% of the Fortune 500 companies already use its services.

ServiceNow primarily gauges its growth in terms of its subscription revenue and its current remaining performance obligations (cRPO), or the future revenue it expects to realize from its existing contracts over the following 12 months. Both of those year-over-year growth rates have consistently hovered near 30% in constant currency terms over the past year.

Data source: ServiceNow, constant currency terms. YOY = year over year.

That's why the reduction of its full-year subscription revenue guidance to just 24% growth initially rattled investors. But on closer inspection, it attributed that entire guidance cut to currency headwinds. On a constant currency basis, it still expects to achieve its original target of 28% growth.

It continues to lock in new customers

ServiceNow continues to gain large customers that sign annual contract values (ACV) of more than $1 million, while its renewal rate has remained consistently above 99%.

Data source: ServiceNow, constant currency terms. YOY = year over year. 

During the company's second-quarter conference call, CFO Gina Mastantuono said that while many of its customers faced macroeconomic challenges, they were turning to ServiceNow to "reinvent their business models so they can innovate to win and come out of this moment stronger than ever."

In other words, ServiceNow is similar to other evergreen cloud software companies like Salesforce, which also helps large companies digitally streamline their businesses, automate tasks, and cut costs to counter the macroeconomic headwinds.

Rock-solid margins

ServiceNow's subscription-based gross and operating margins have also remained broadly stable over the past year on a non-GAAP (generally accepted accounting principles) basis, which suggests it still has plenty of pricing power and scale to ride out the near-term headwinds.

Data source: ServiceNow, non-GAAP. YOY = year over year. 

For the full year, it expects its subscription gross margin to rise by 1 percentage point to 86%. It expects its operating margin to stay flat at 25% as it offsets a currency headwind of 1 percentage point with more disciplined spending measures.

But can ServiceNow maintain its premium valuation?

ServiceNow's growth rates are robust, and it still expects its annual revenue to rise at a compound annual growth rate of at least 22.5% from 2021 to 2026, to over $16 billion by the final year.

It reaffirmed that forecast, which it raised from $15 billion in May, during the conference call. That confidence arguably makes ServiceNow more trustworthy than the growing number of tech companies that have recently walked back or simply glossed over their lofty multi-year goals.

However, ServiceNow's premium valuation also reflects those strengths. It already trades at more than 60 times forward earnings and 10 times next year's sales. By comparison, Salesforce -- which is much larger but growing at a slower clip -- trades at less than 40 times forward earnings and just five times next year's sales. Therefore, ServiceNow's stock could already be priced for perfection at these levels.

It's still a good long-term investment

ServiceNow's stock isn't cheap yet, and its near-term upside potential could be limited by rising rates and other macro headwinds. However, investors who gradually accumulate shares of this high-quality cloud company will likely be rewarded over the long term as it continues to gain new customers, expand its ecosystem with new services, grow its margins, and attract more attention from the bulls.