In 2022, investors reacted to rising interest rates by selling their shares of high-growth stocks, such as ServiceNow (NOW 1.02%), and buying stocks in more stable sectors, such as utilities and healthcare. This trend occurs because high-growth stocks are more sensitive to interest rate movements. When interest rates rise, the cost of borrowing money increases, making it more expensive for companies to invest in their businesses, leading to lower earnings growth, which can hurt the stock prices of high-growth companies. As a result of this trend, ServiceNow's stock declined 40% last year.
As investors began seeing the light at the end of the tunnel for the Federal Reserve ending its relentless interest rate hike campaign in 2023, positive sentiment returned to high-growth software stocks, and investors began valuing companies like ServiceNow much higher. Consequently, the stock price is up 45% year to date, compared to the S&P 500, up only 16%.
Despite worries by some about a potential global economic decline that could result in reduced IT spending and adversely affect ServiceNow's revenue growth, investors who prioritize growth should consider purchasing the stock. That's true even after its recent big price move this year. Here's why.
ServiceNow is in a great business
ServiceNow is one of the leading companies developing cloud-based software that helps businesses automate and manage workflows, which are sequences of tasks needed to achieve a specific goal. These tasks can be anything from customer service to Information Technology (IT) support to human resources. The platform provides a single place for businesses to manage all their workflows, which can help improve efficiency and reduce costs.
One huge secular trend driving growth in workflow automation is digital transformation, defined as adopting and implementing electronic systems and resources that can store and process data. Digital transformation can encompass using hardware like computers, laptops, tablets, smartphones, sensors, cameras, and microphones to using the internet, cloud computing, artificial intelligence, machine learning, robotics, blockchain, and other technologies.
As businesses digitally transform, managing workflows manually can become increasingly complex and time-consuming. Workflow automation software can help businesses to simplify workflows and make them more efficient. For example, onboarding new employees may involve several departments, including Human Resources, IT, and Finance. By automating tasks such as email correspondence, document creation, and employee task assignments, workflow automation software can help businesses achieve greater output and effectiveness. Additionally, it can help manage the massive onslaught of data generated from many different sources by automating data entry and processing.
Due to digital transformation driving demand, the workflow automation market is large and growing. According to Grand View Research, this market will grow at a compound annual growth rate of 33%, from $11.59 billion at the end of 2023 to $86.63 billion in 2030. So, ServiceNow's revenue growth has a huge tailwind behind its back because of the industry's rapid growth rate.
The market it plays in is competitive
One significant risk you should remain aware of should you invest is that ServiceNow competes in a highly competitive and dynamic market with relatively low barriers to entry. Many companies offer similar products and services, and it is relatively easy for new companies to enter the market. ServiceNow's competitors include Salesforce, WorkDay, Oracle, and many others. These companies are more prominent than ServiceNow and have greater name recognition. Furthermore, they have a wealth of experience in the industry, well-established customer relationships, a larger user base, more capital and technical expertise, and better marketing budgets.
If ServiceNow fails to innovate quickly enough, adapt to changing customer needs and preferences, or differentiate products and services from competitors, it could lose market share, customers, and revenue.
ServiceNow is growing like a weed
On the other hand, ServiceNow has established itself as a clear leader in a fiercely competitive market, with an impressive number of customers whose annual contract value (ACV) exceeds $1 million. This number has grown from 1,082 in 2020 to 1,637 in 2022, indicating that ServiceNow has a proven track record of attracting and keeping valuable clients willing to pay a premium for the company's products and services. This growth demonstrates the company's exceptional customer satisfaction, loyalty, and expansion into its addressable market. Moreover, the increasing number of high ACV customers has significantly contributed to ServiceNow's revenue, profitability, and cash flow, underscoring the company's financial strength and stability.
ServiceNow has grown its revenue rapidly and consistently over the past five years, outperforming many of its peers in the software industry. According to CSImarket, ServiceNow's five-year average revenue growth was 30%. In comparison, the software and programming industry's revenue grew at an average annual rate of roughly 19%, and the S&P 500's revenue growth rate only increased by 11%. Moreover, analysts expect the incredible revenue growth to continue. Consensus analyst revenue growth for ServiceNow for the next five years is between 20% and 25%, well above the Statista estimate of 7% revenue growth for the global IT sector, making it an attractive option for investors looking for above-average growth opportunities.
The company also has strong and growing earnings. Simply Wall St reports a consensus analyst annual earnings growth forecast for ServiceNow for the next three years of 29%. In comparison, the earnings growth estimate for the software industry is 20%.
Why you should consider ServiceNow stock
ServiceNow is a strong buy for investors looking for a growth stock that can weather an economic downturn. The company primarily sells to large enterprises, which are less likely to reduce IT spending during a downturn. Additionally, its software helps companies save money and improve efficiency, making it even more attractive to businesses during a recession. Finally, the company has a strong track record of growth, even in difficult economic times. As a result, this stock is one that investors can confidently buy and hold for the long term.
