August and September tend to be weak months for the stock market. Seasonality is the cause; many Wall Street fund managers are away for the summer, which means volume tends to be light and fewer buyers are standing by to support dips in the market.
Right on cue, the Nasdaq-100 index declined by 5% in August. Many individual stocks have suffered much steeper declines -- Apple, the world's largest company, has shed 9% of its value this month.
But it's not all doom and gloom. Machine learning (ML) specialist Splunk (SPLK) just released its quarterly financial results for the three months ended July 31, and investors sent its stock price soaring. It's now sitting on a gain of 7% for August, far outperforming the Nasdaq-100. Here's why it's likely to go higher.
Splunk provides powerful machine learning tools to businesses
Machine learning is a subfield of artificial intelligence (AI), and here's how Microsoft explains the difference between them:
An "intelligent" computer uses AI to think like a human and perform tasks on its own. Machine learning is how a computer system develops its intelligence.
Splunk offers an entire portfolio of ML-powered software, from observability tools to cybersecurity tools. Its specialty is helping businesses extract value from their digital information by ingesting mountains of data, processing it, and spitting actionable insights out the other side. This often happens in real time, which empowers customers to make instant decisions to reduce costs and maximize revenue.
Splunk serves more than 15,000 customers, from Domino's Pizza to the McLaren Formula 1 racing team. McLaren uses Splunk to stream data from almost 300 individual sensors on each of its cars. From there, ML is used to diagnose technical issues and unlock additional performance on race weekends, all in real time so the team can make instant adjustments.
In July, Splunk announced the release of Splunk AI, which is a collection of new generative AI tools built upon large language models to make the company's platform more accessible. For example, customers can chat with the new Splunk AI Assistant -- much like they would with a chatbot like ChatGPT -- to help them understand different outputs delivered by the platform and its ML algorithms.
That means more employees can use and understand Splunk, as opposed to just engineers and technical staff, which could result in the technology being deployed in more areas of each customers' business. That might eventually increase the amount of money each customer is spending with Splunk each year.
Image source: Getty Images.
Here's why Splunk stock soared in August
For several years prior to 2022, U.S. technology companies were rewarded by investors for adopting growth-at-all-costs strategies, even at the expense of profits. But everything changed when the Federal Reserve embarked on its most aggressive campaign to hike interest rates in its history last year to fight soaring inflation.
Investors started to shun those tech companies that were producing losses because they were perceived as risky in the uncertain economic environment. As a result, many of them reined in their spending, sacrificing customer acquisition and fast revenue growth to generate a profit. Splunk was one of them.
In the fiscal 2024 second quarter (ended July 31), the company's revenue grew by just 14% year over year, less than half the 32% growth rate from the same quarter in fiscal 2023. Splunk trimmed its operating costs by 2% during the quarter, which means it invested less money in research and development and staff, resulting in slower revenue growth.
The benefit of that strategy was observed at the bottom line. Splunk made a net loss of $63 million in Q2, a substantial reduction from its $209 million net loss in the year-ago quarter.
But Splunk has asked investors to focus on its trailing-12-month free cash flow, which is a non-GAAP (generally accepted accounting principles) metric that excludes noncash and one-off expenses like stock-based compensation, because it's a better reflection of the company's true profit potential. In Q2, its trailing-12-month free cash flow was $804 million, a whopping 273% increase compared to its result 12 months prior.
That's a primary reason Splunk stock has popped higher this month.
Why Splunk stock is a buy right now
Splunk CEO Gary Steele believes organizations are becoming more complex due to their reliance on cloud computing. These companies increasingly run their operations and sales channels online, which creates visibility and monitoring challenges. He says customers constantly tell him how critical Splunk's observability and security platforms are in keeping track of their environments in a multicloud world.
Splunk AI goes a step further by potentially involving more of a customer's nontechnical employees in the process. That contributes to a valuable opportunity for Splunk, which could be worth more than $100 billion right now, according to internal estimates.
Considering the company has only accumulated $3.8 billion in annual recurring revenue (ARR) so far, it has a substantial growth runway ahead. And here's the good news for investors: Splunk stock is currently cheap, which means now might be a great time to take a long-term position.
Despite a strong August, Splunk stock is still trading 47% below its all-time high following a difficult 2022 for the tech sector. Based on the company's ARR and market capitalization of $19.3 billion, the stock trades at a price-to-sales (P/S) ratio of 5. That's near the cheapest P/S valuation since Splunk became a publicly traded company in 2012, and it spells opportunity for investors.
