The bear market of 2022 was brutal for software stocks, but 2023 is shaping up to be a very different story. Software, especially cloud-based companies putting up resilient growth in spite of economic challenges, are making a big comeback.
Inbound marketing and customer relationship management software company HubSpot (HUBS -0.78%) has been no exception. Share prices have nearly doubled so far in 2023, though they remain about 34% below all-time highs last reached in late 2021.
Investors are optimistic about what the future could hold for this top software marketing and automation outfit, but is it a reasonable buy after the big run-up?
Resilient growth, cloud slowdown or not
HubSpot's marquee software is aimed at inbound marketing management -- a set of tools that help customers manage their marketing activity via things like blog posts, videos, social media, and other content creation. The company has historically been focused on small- and medium-sized businesses (SMBs) as it has expanded beyond its core to other proficiencies like customer relationship management (CRM), operations management, and the like.
This creates the perception that HubSpot is a Salesforce competitor -- and in a way, it is. Salesforce's extensive software library, however, is more suited for larger enterprises rather than SMBs. For now, let's call HubSpot a Salesforce peer instead.
Cloud-based software companies have been reporting sharp slowdowns in growth this year as many of their customers look for ways to conserve cash and delay new spending deals. Even mighty Salesforce is in this boat.
Perhaps owing to its focus on smaller (and often faster-growing) businesses, HubSpot's revenue growth has been comparatively resilient so far in 2023. Q1 revenue was up a very healthy 27% year over year to nearly $502 million (or up 30% when excluding the negative effects of currency exchange rates), compared to year-over-year growth of 41% in Q1 2022.
To be sure, HubSpot isn't immune from global economic worry, but it's holding up quite well.
Pervasive loss-generating operations -- for how much longer?
One reason the bear market of 2022 was so severe for many high-growth companies was the lack of profitability, and by some metrics, this is still HubSpot's Achilles' heel. It generates positive free cash flow, which is good, but its employee stock-based compensation remains high ($83 million last quarter, up 82% from a year ago, and higher than the $63 million in free cash flow generated during the quarter). The result is flatlining free cash flow on a per-share basis.
Data by YCharts.
This is the primary reason HubSpot still reports a generally accepted accounting principle (GAAP) net loss -- $38.3 million in net losses, to be exact, in Q1. For strict value investors, HubSpot isn't going to meet the criteria for an investment.
Wall Street analysts' consensus is that HubSpot won't begin generating GAAP net income until 2025, though it should remain free cash flow positive along the way.
Is the stock a buy?
All this doesn't mean there's no value in HubSpot. As management has explained, its SMB customers are still healthy and growing. And one of HubSpot's priorities is scaling up its product portfolio alongside those customers. HubSpot thinks it is a top choice for marketing, sales, and customer management software for smaller businesses that are rapidly expanding.
In other words, HubSpot could remain a high-growth cloud software stock for a long time. But the valuation is starting to look a bit stretched after the big rally in the first half of 2023. Shares trade for nearly 15 times trailing-12-month sales, and about 150 times free cash flow.
For a business that is posting stalled-out free cash flow-per-share growth, I'd be wary about buying just now. I think there are better buys right now -- including Salesforce, which is still growing modestly but rapidly increasing its profit margins.
For now, I rank HubSpot stock as a hold but keep an eye on this one.
