When it comes to software-as-a-service businesses (SaaS), few have been more successful than ServiceNow (NOW 2.63%). Its software helps organize IT workflows across all business segments, creating a seamless interface for employees and customers.
The stock has been a stalwart over its public company life, returning nearly 2,000% from its IPO price. Does the business have enough room to continue growing? Or has it reached its full potential? Let's dig in.
A widely used IT platform
To expand on ServiceNow's offerings, it is all about making IT workflows more efficient. With businesses utilizing multiple software and hardware products, it's easy for something to go wrong. And when something inevitably goes wrong, it's usually not an easy fix. However, ServiceNow's software allows its customers to predict issues and also minimize the impact when something goes wrong due to response automation.
ServiceNow's product is widely used -- about 80% of the 500 largest U.S. companies utilize its product suite. Because of its deep integration within many IT systems and its subscription basis, customers are unlikely to cut ServiceNow due to economic hardships. To back this claim up, ServiceNow saw a 99% renewal rate in the second quarter.
However, many investors were concerned with customer acquisition, as ServiceNow (and many of its SaaS brethren) isn't a cheap service. Still, ServiceNow executed well in a challenging economic environment.
Solid growth across its subscription plan
In Q2, ServiceNow saw its subscription revenue rise 25% year over year (YOY) to $1.7 billion, and its current remaining performance obligations (RPO, the revenue it expects to realize in the next 12 months from previously signed contracts) rise 21% to $5.75 billion. This is a healthy result from a leading SaaS company, so SaaS investors shouldn't be worried about spending dropping off.
However, ServiceNow still cut its full-year sales guidance from 26% to 24% growth. While most of this is due to currency impacts, a slight cut ($33 million) for new business isn't bad. It shows there are some headwinds, but for the most part, businesses are still spending. Most of this growth isn't coming from new customers either. Instead, 85% of new business comes from existing customers, which shows how valuable ServiceNow's tools are and how its expanding product suite is being adopted.
ServiceNow also has decent margins, with Q2's non-GAAP (adjusted) operating margin reaching 23%. While investors must always be cautious with using non-GAAP metrics (due to subtracting stock-based compensation), if a company is profitable on a GAAP basis, I'm less worried as the company isn't trying to hide its unprofitability. Plus, ServiceNow's outstanding shares have only risen 17% in five years; that's a pretty tiny shareholder dilution compared to a 350% stock return.
With a great quarter behind it, investors may be wondering: Is ServiceNow a buy now?
After examining a business' financial results and seeing good signs, it's critical to check valuation, as even the best companies bought for the wrong price can be disastrous investments. However, with ServiceNow trading at 15 times sales, it's not absurdly overvalued. Its valuation is also pretty close to where it was during 2018, which was the last time the Federal Reserve raised its rates.
With its growing product suite, profitability, and a reasonable valuation, I see no reason why ServiceNow isn't a solid stock to buy. Additionally, its solid quarter gives SaaS investors the green light to continue investing, as companies with vital products critical to a digital transformation are still seeing growth.
The SaaS space is full of innovative companies with massive opportunities, and ServiceNow has solidified itself as one of the leaders.
