Is ServiceNow Stock a Buy?

ServiceNow's (NOW -0.69%) stock rose 3% on Jan. 26 after the cloud-based digital workflow services provider posted its fourth-quarter earnings report. Its revenue rose 20% year over year to $1.94 billion, which matched analysts' expectations, while its adjusted earnings increased 56% to $2.28 per share and cleared analysts' estimates by $0.26.

Those headline numbers seem sound, but is ServiceNow still a worthwhile investment in this challenging market for high-growth tech stocks? Let's review its growth rates, near-term challenges, and valuations to decide.

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A recession-resistant business model

ServiceNow's services enable companies to streamline their unstructured work patterns into automated workflows. Doing so can enable an organization to expand its business efficiently, reduce its operating expenses, and strengthen its support for hybrid and remote workers. Its business model is naturally insulated from macroeconomic headwinds, since economic downturns often force companies to streamline their businesses.

But ServiceNow hasn't been immune to the strong dollar. On a constant currency basis, its revenue rose 25.5% year over year in the fourth quarter. This was 550 basis points higher than its reported growth. However, that gap might gradually narrow this year if interest rates stabilize and the dollar weakens against other currencies.

The most bullish numbers from ServiceNow's Q4 report

On a constant currency basis, ServiceNow's subscription revenue (which accounted for 96% of its top line) rose 27.5% year over year in Q4. That represented a slight slowdown from its 28.5% growth in the third quarter, but two other key growth metrics -- its constant currency growth in current remaining performance obligations (cRPO), or the revenue it expects to recognize from its existing contracts over the next 12 months and higher-value customers with an average contract value (ACV) of over $1 million -- both accelerated in Q4.

Data source: ServiceNow. YOY = Year-over-year. *Constant currency.

The acceleration, which occurred as many other cloud-based software companies grappled with slower enterprise spending, supports the bullish notion that ServiceNow's business model is evergreen. Its high renewal rate -- which remains at around 98% -- also indicates that the challenging macro headwinds aren't driving away its existing customers.

The adjusted gross margin of ServiceNow's subscription business rose by a percentage point year over year to 86% in 2022, which suggests it still has plenty of pricing power against comparable "digital transformation" peers like Salesforce (CRM -1.59%), Atlassian (TEAM -0.75%), and Workday. Its adjusted operating margin also increased by a percentage point to 26%, which indicates that economies of scale are kicking in as many other cloud companies struggle to break even.

It expects a slight slowdown in the first quarter

ServiceNow ended 2022 on a high note, but it expects a slight slowdown this year. For the first quarter of 2023, it expects its subscription revenue to rise 25% to 25.5% in constant currency terms, for its cRPO to increase 24% on the same basis, and for its adjusted operating margin to dip to 24%.

For the full year, it expects its subscription revenues to rise 23.5% in constant currency terms. It expects its adjusted subscription gross margin to dip two percentage points to 84% as it ramps up its investments, but for its adjusted operating margin to hold steady at 26% as it optimizes its sales and marketing expenses. During the conference call, ServiceNow CFO Gina Mastantuono said the company had "prudently factored in the evolving macro crosswinds" into its 2023 guidance, which indicates the company is resistant -- albeit not immune -- to the macro and geopolitical challenges.

Analysts expect ServiceNow's reported revenue and adjusted earnings to rise 21% and 19%, respectively, in 2023. That outlook is bright, but a lot of that growth has already been baked into ServiceNow's stock at 49 times forward earnings and 11 times this year's sales. By comparison, Salesforce -- which is growing more slowly than ServiceNow -- trades at 27 times forward earnings and five times this year's sales. Atlassian -- which is generating stronger sales growth but much weaker earnings growth -- trades at 116 times forward earnings and 12 times this year's sales.

ServiceNow is still worth buying

ServiceNow's outlook wasn't perfect, but it still plans to generate over $16 billion in revenue in 2026, which implies its top line will expand at a compound annual growth rate (CAGR) of at least 20.7% from 2022 to 2026. That rosy long-term forecast, along with the resilience of its core business, suggests ServiceNow's stock deserves to trade at a premium valuation -- and that it could still generate much bigger gains over the next few years.