The e-signature company DocuSign (DOCU -0.26%) has been a hot stock, appreciating over 40% over the past three months. That coincides with a broader tech stock rally, but there could be some underlying fuel to DocuSign's rise.
Rumors are swirling of a potential buyout. This could mean that investors are bidding up the stock in anticipation of a deal being struck at a premium to its current valuation.
That makes the stock more speculative, and should give investors pause before jumping into Docusign with both feet. Here is what you need to know.
First, what DocuSign stock can offer investors
DocuSign was a pandemic sensation when lockdowns pushed the entire business world to e-signatures overnight. The company saw a significant growth spurt, accumulating approximately 75% of the e-signature market, according to research by Deloitte. DocuSign's revenue growth has faded since the pandemic, however, and it's getting harder to label DocuSign a growth company given that revenue grew just 9% year-over-year in Q3 of its fiscal year 2024.
Nonetheless, the company sits in a pretty solid financial spot right now. DocuSign is doing $2.7 billion in annual revenue at nearly 80% gross margins. That translates to solid earnings, which analysts believe will finish its fiscal 2024 year (ending January 2024) at $2.87 per share. That values the stock at 20 times earnings, a very reasonable price tag if it can grow fast enough to muster somewhere around 10% earnings growth over time.
The company has international growth opportunities to help that happen. Currently, international sales are just a quarter of total revenue, and that figure grew 18% over 2022 in Q3, so that's outpacing the broader company.
DocuSign doesn't seem like a bad company, so why might investors avoid the stock?
There are two red flags to be aware of.
1. DocuSign could struggle to protect its market share
DocuSign is today's market leader, but it's a small fish swimming in a large and unforgiving sea of enterprise software companies. Among them is Adobe, which is many times DocuSign's size and offers a competing product in Adobe Sign, which it packages with its Document Cloud software.
Adobe recently announced its Q4 earnings, noting that sales for Document Cloud grew 17% year-over-year to $721 million. If you annualized that number, it's roughly the same as DocuSign's annual revenue -- so a similar-sized figure growing twice as fast could be notable. Document Cloud is more than just Adobe Sign, so Adobe's success isn't necessarily a direct reflection on DocuSign, but it's something investors need to watch in the future.
The long-term concern should be whether DocuSign can expand on its core e-signature product enough to justify customers keeping it versus consolidating e-signatures into Adobe's many other offerings.
2. Takeover rumors have cast a cloud over the stock
The timing of DocuSign's rally makes it challenging to figure out what exactly is driving it. The broader market rallied to end 2023 and started the new year strong. However, around the second week of January, it was reported that two private equity firms, Bain Capital and Hellman & Friedman, were competing to buy the company.
A potential takeover often causes a buying frenzy for a stock because investors anticipate a buyout offer will come at a premium to the current share price -- sometimes it's pretty lofty. Typically, the buyer has to pay more than the market price for the company. Otherwise, the target company's shareholders wouldn't be incentivized to vote for a sale.
Without a clear explanation for the rally, the stock becomes potentially riskier. For example, suppose DocuSign doesn't get bought. Investors who purchased the stock only to benefit from a sale would likely sell their shares. That's important, because with the stock up 40% in three months, the drop could be steep if it becomes clear that DocuSign won't sell.
Do investors buy a stock because they believe in the business, or is it a trade to make a quick profit? That's a personal decision, but it's often not a good idea to turn an investment into a trade or a trade into an investment.
With DocuSign, it's hard to tell which is which right now.
