Thanks to the viral success of OpenAI's ChatGPT, the world has awakened to the potential artificial intelligence (AI) has to make businesses more efficient. It's a timely turn of events, given that inflation and managing workforces remain hot topics in the corporate boardrooms of many companies.
But what about investors? The market seems to think the AI hype is the real deal, and any business working on AI (or simply invoking the phrase) is seeing positive stock movement.
Two cases in point: Nvidia (NVDA -2.48%) and ServiceNow (NOW -4.28%), which recently announced a new collaboration. Nvidia stock's meteoric rise was well documented this year, and a very solid case can be made that it rose too far too fast.
But what about ServiceNow: Is it a buy?
ServiceNow's AI bid to make business processes better
ServiceNow is a "digital transformation" platform. Basically, the company's software products help customers streamline workflows, find and fix inefficiencies in those workflows, and connect various departments throughout an organization so that informed decisions are made. ServiceNow customers range from tech development to human resources departments.
"Workflow management" is an ambiguous description, and might be difficult to grasp. But suffice it to say ServiceNow's software is powerful and helps thousands of big organizations embrace the new digital era (i.e., it helps customers save money). The company has $7.6 billion in revenue over the last reported 12-month period -- more than double trailing-12-month sales at the beginning of 2020.
Given its importance in the business world, it's not surprising ServiceNow is making a bid on AI, too. In fact, teaming up with Nvidia speaks volumes about how close these two enterprises have become.
ServiceNow is tapping Nvidia's GPU-powered software to train proprietary generative AI algorithms for its workflow management platform. Automating repetitive tasks is what ServiceNow does, and text-based prompts and AI chatbots to fix workflow choke points and train employees could be a great go-to-market tool. Not to mention making its products stickier with existing customers.
Interestingly, though, after Nvidia trains ServiceNow's new AI tools, Nvidia itself will be one of the first customers. Basically, Nvidia is eating its own cooking and will use the product it helped create to turn around and make its own AI software models better, forming a virtuous cycle of AI process improvement.
Time to buy ServiceNow?
The last time I checked in and wrote about ServiceNow in late December 2022 would have been a great time to buy. Shares are up well over 30% since then. My only consolation for not buying ServiceNow is that I had recently added to my large existing Nvidia stock position.
But what about now? Much like Nvidia, ServiceNow stock doesn't come cheap. Shares trade for 261 times trailing-12-month earnings (or 49 times trailing 12-month free cash flow), and 54 times expected fiscal-year 2023 earnings per share. After years of fast expansion, this business is starting to scale to profitability based on generally accepted accounting principles (GAAP), which helps explain the high valuation.
Nevertheless, despite economic headwinds and ongoing negative effects from currency exchange rates, ServiceNow is expecting to grow its subscription revenue by about 23.5% year over year, all the while generating a very healthy free-cash-flow profit margin of 30%. Clearly, customers think ServiceNow's workflow-efficiency and money-saving software is worth spending on. A jolt of new AI could keep the business in growth mode.
While I think Nvidia is worth a wait-and-see approach right now, ServiceNow stock could still merit a nibble here. If you are in need of some cloud software stocks in your portfolio, this could be a great dollar-cost-average candidate to consider, given the high premium on the stock.
