While big integrated technology giants are back in earnings growth mode, cloud software companies -- especially small ones -- have remained in defensive mode in 2023. But not all of them. Monday.com (MNDY 2.81%) has been an exception. The company dropped yet another excellent quarterly earnings report on Monday morning, keeping the stock in the rally it's been enjoying for most of the last year.
The stock is up over 50% in the last 12 months. Is it too late to buy?
The Monday.com advantage
Monday.com is a small software company, but it's made a name for itself within its competitive industry with highly customizable software that can be used for everything from customer and sales management to project management. But as interest rates have risen in the last year from the U.S. Federal Reserve's fight against inflation, business spending has slowed, and Monday.com quickly pivoted to what investors want to see most from their small software stocks. Right now, that's not just sales growth but a balance of growth and profitability.
Monday reported Q3 2023 revenue of $189.2 million, up 38% from last year. And its GAAP operating loss improved to just $2.5 million, compared to an operating loss of $28.2 million in the year-ago quarter. However, Monday did swing to a GAAP net profit of $7.5 million in the quarter, a small consolation prize in a rising interest rate environment. It's a result of the massive $1 billion in cash and short-term investments on the balance sheet, which generate interest income for the company.
Free cash flow (FCF) was $65 million, good for a FCF margin of 34%, up from a FCF margin of just 10% in Q3 2022. Some of the difference between FCF and GAAP net income was $26.6 million in employee stock-based compensation, which Monday has been able to keep roughly flat year over year in an ongoing effort to keep overall expenses in check.
Life is still tough for small software stocks
Of course, not all is peachy at Monday. Just as many other cloud software companies have been reporting slowing growth, so has this one. Monday customers themselves are also looking for ways to cut costs and conserve cash, and that often means delaying deployment of new software. The revenue guidance for Q4 ($196 million to $198 million) implies at least 31% year-over-year growth. However, that outlook is a modest 4.8% sequential increase, or a 19% increase on an annualized basis.
Put another way, Monday's rapid growth could be coming to an end, at least for the time being.
It's thus a good thing that management put in the work over the last year to get profit margins in a range that will keep shareholders happy. Building a profitable business early on is an important task for small software companies looking to compete against giant competitors. Monday will need to build on its success to date with additional product offerings to build out a more robust network of partners and customers going forward.
With that in mind, it's still best to be cautious with this stock. Monday has a premium valuation (40 times enterprise value to trailing-12-month FCF), which can cause wild swings in the stock price from one quarter to the next. If you consider adding this small cloud software company to your basket of small- and mid-cap stocks, nibble in small chunks or consider doing so using a dollar-cost averaging strategy to accumulate a position over time.
