ServiceNow's (NOW -11.29%) stock price jumped 13% on Oct. 27 in response to its third-quarter earnings report. The cloud-based digital workflow services provider's revenue rose 21% year over year (27.5% in constant currency terms) to $1.83 billion, which narrowly missed analysts' estimates by $20 million. Its adjusted net income grew 27% to $398 million, or $1.96 per share, which cleared the consensus forecast by 11 cents.

ServiceNow is still generating impressive growth, but is it the right stock to buy as rising rates rattle the tech sector? Let's weigh the five main reasons to buy ServiceNow against one reason to sell it.

Person working outdoors on a phone and a laptop.

Image source: Getty Images.

1. The secular expansion of the digital workflow market

ServiceNow's cloud-based services help companies streamline and automate their unstructured workflows. Those improvements enable companies to reduce their expenses, optimize their operations, expand efficiently, and improve their support for hybrid and remote workers.

ServiceNow already serves about 80% of the Fortune 500, but it still has plenty of room to expand as companies continuously digitize their businesses. The entire workflow management systems market could still grow at a CAGR (compound annual growth rate) of 30.6% from 2021 to 2028, according to Grand View Research, and ServiceNow should remain a top play on that growing market. 

2. Its robust growth in subscription revenue

ServiceNow's growth in subscription revenue, which account for most of its top line, supports that bullish outlook. Between 2012 and 2021, ServiceNow's subscription revenue increased from $205 million to $5.5 billion, representing a CAGR of 44%.

Its growth is gradually cooling off, but it's still grown its subscription revenue at nearly 30% on a constant currency basis over the past year. Its current remaining performance obligations (cRPO), or the revenue it expects to recognize from its existing contracts over the next 12 months, have also grown at a comparable rate.

Metric

Q3 2022

Q2 2022

Q1 2022

Q4 2021

Q3 2021

Subscription revenue growth

28.5%

29.5%

29%

30%

30%

cRPO growth

25%

27%

30.5%

32%

32%

Data source: ServiceNow, constant currency terms.

3. Its resilience against tough macro headwinds

ServiceNow expects its subscription revenue to rise 28.5% on a constant currency basis for the full year, compared to its 28% growth in 2021. During the conference call, CEO Bill McDermott said the "secular tailwinds were stronger than macro crosswinds," and that the expansion of the cloud, data infrastructure, cybersecurity, risk management, analytics, and remote work markets would continue to drive its long-term growth.

ServiceNow expects currency headwinds to reduce its reported growth in subscription revenue to just 23% this year, compared to its 30% growth on the same basis in 2021. But currency headwinds are cyclical and its core business is still firing on all cylinders. ServiceNow believes it can generate over $16 billion in annual revenue in 2026, which implies its top line will expand at a CAGR of at least 22.5% from 2021 to 2026.

4. Its growth in large customers

ServiceNow has consistently locked in larger customers, which have an average contract value (ACV) of over $1 million, even as the macro headwinds forced many larger companies to rein in their spending on big cloud deals.

Metric

Q3 2022

Q2 2022

Q1 2022

Q4 2021

Q3 2021

Customers with over $1M in ACV

1,530

1,463

1,401

1,359

1,266

Growth (YOY)

21%

22%

24%

25%

25%

Data source: ServiceNow. YOY = Year over year.

In the third quarter, ServiceNow also revealed that its number of customers with over $10 million in ACV rose 60% year over year, which represented an acceleration from that high-value cohort's 50% growth in the first quarter.

5. Stable profits and consistent margins

Unlike many other cloud-based software companies, ServiceNow is consistently profitable by both GAAP (generally accepted accounting principles) and non-GAAP measures. Its non-GAAP subscription gross and operating margins also remained unwaveringly consistent over the past year:

Metric

Q3 2022

Q2 2022

Q1 2022

Q4 2021

Q3 2021

Subscription gross margin

86%

86%

86%

85%

85%

Operating margin

26%

23%

25%

23%

26%

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

For the full year, ServiceNow expects its subscription gross margin to rise by a percentage point to 86%, and for its operating margin to stay flat at 25%. That stability indicates it has plenty of pricing power and should remain firmly profitable.

The one reason to sell ServiceNow: Its valuation

Analysts expect ServiceNow's revenue to rise 24% this year and 23% in 2023. They expect its adjusted earnings per share to grow 23% this year and 26% in 2023. Based on those expectations, ServiceNow's stock trades at 40 times forward earnings and nine times next year's sales.

In comparison, Salesforce (CRM -21.37%), which is larger and growing at a slower rate than ServiceNow, trades at 29 times forward earnings and five times next year's sales. Therefore, the bears might argue that ServiceNow is still a bit too pricey to buy in this challenging market for growth stocks.

However, I personally believe ServiceNow's strengths easily justify its higher valuation. The next few months might be volatile, but this is a stock that could still deliver more multibagger gains over the next few years.