Someone forgot to tell ServiceNow (NOW 1.02%) that the cloud software industry has been slowing down in 2023. The digital transformation platform's revenue growth has actually been accelerating throughout the last year, and the stock has picked up steam as 2024 approaches. Shares of ServiceNow are up 80% in 2023 with just weeks left to go until the new year.
A high valuation has prevented many investors from pulling the trigger on buying this top cloud stock. After an epic run, is it still a top buy for 2024?
A next-gen platform for the future of work
ServiceNow provides numerous solutions for businesses to manage their workforce and customer experiences. Its platform spans digital workflow management tools, from AI that helps find bottlenecks that are slowing down the completion of tasks to cloud observability solutions that help with app performance.
ServiceNow landed on the radar of many investors this past summer after an expanded partnership was struck with Nvidia. ServiceNow said it would adopt Nvidia's latest and greatest AI systems to improve its own platform, and in turn, Nvidia would expand its use of ServiceNow in its own workflow management for developing more powerful chips and generative AI systems.
This type of AI used to automate more employee tasks is powering "digital transformation" among big customers. In a year like 2023 where cost-cutting has been a top priority in the corporate world, it's helped keep demand high for ServiceNow's software. And, after the bear market of 2022, the company's revenue growth has been ratcheting up again.
|
Period |
Total Revenue |
Increase (YOY) |
|---|---|---|
|
2021 |
$5.9 billion |
30% |
|
2022 |
$7.25 billion |
23% |
|
Q1 2023 |
$2.1 billion |
22% |
|
Q2 2023 |
$2.15 billion |
23% |
|
Q3 2023 |
$2.29 billion |
25% |
Data source: ServiceNow. YOY = year over year.
Even better, though, has been ServiceNow's rapid progress on profitability. Generally accepted accounting principles (GAAP) income from operations was $492 million in the first nine months of 2023, compared to just $200 million in the same period in 2022. Free cash flow (FCF) was $1.36 billion in the first nine months of 2023 (a healthy FCF profit margin of 21%), with the discrepancy between GAAP profitability primarily driven by employee stock-based compensation.
As for that employee stock-based compensation, ServiceNow management reported it repurchased $282 million worth of stock in Q3 2023. This is part of the company's first-ever stock repurchase program, which is aimed at offsetting the impact of dilution from ongoing employee stock-based compensation. About $1.2 billion worth of stock repurchase authorization remained at the end of the quarter.
Expect some turbulence, but a top cloud stock for the long term?
After the big run-up in stock price in 2023, ServiceNow trades for a high premium of 90 times trailing-12-month earnings per share, or about 60 times trailing-12-month FCF. Of course, part of the premium exists because ServiceNow's profit margins are expected to rise rapidly over the course of the next few years. To wit, shares trade for a bit more reasonable 55 times Wall Street analysts' expectation for 2024 earnings per share.
ServiceNow is nevertheless an expensive stock as we head into the new year. That can cause some turbulence in stock price, including steep sell-offs if ServiceNow misses some short-term financial estimates from one quarter to the next.
However, given the company's fast-and-steady growth for years, and leadership in cloud-based and AI-powered software, investors are rightfully optimistic about the business's trajectory. As I explained this time last year, I think a stock like ServiceNow is best bought in batches over the course of time, perhaps using a dollar-cost averaging plan. This still seems like the right strategy for those investors interested in the long-term potential (a decade and beyond) for ServiceNow.
