Workday's (WDAY +0.77%) share price has seen significant volatility over the last year, but the stock has risen roughly 17% over the period. Prior to the announcement of the company's third-quarter report earlier this week, the past month saw shares climb roughly 12.5% in conjunction with the addition of new companies to Workday's client list and interest in new human capital management applications. The release of the quarterly results then prompted a roughly 6% decline in the company's valuation. Taking a more long-term view, Workday's valuation has grown roughly 75% since its October 2012 IPO price -- a strong performance compared with roughly 45% growth for the S&P 500 over the same stretch.
There's no denying that Workday has been on an impressive growth trajectory, but it's also worth considering some elements that could cause the company some trouble. The following three factors don't provide concrete evidence that Workday's stock will fall, but they could have significant impacts on valuation and are important points for investors to watch going forward.
Workday's new human resources apps could under-deliver
Thus far, the company has done an admirable job of building cloud-based enterprise resource planning, or ERP, software that integrates with its other offerings. This strength is helping to bridge customers from its premier product, Workday Human Capital Management, to Workday Recruiting and Workday Financial Management. Now, the company is in the process of developing new applications for managing the workplace, and it's pushing into some uncharted territory. Workday Insight Applications is slated for a 2015 launch and will be the company's push into workplace management through predictive analytics.
The new app suite will supply businesses with predictive data and recommendations for management and will be used to map out employee performance analyses, suggestions for career paths, and more. There's a lot of potential in this new applications suite, but if Insight Applications isn't up to par, it could dent Workday's stock. Competing ERP software companies are also targeting predictive management solutions as a potential next big thing in the industry, and the launch of an inferior product could dampen the outlook for Workday's growth prospects.
Missing growth targets could put a major damper on Workday's valuation
Even after the post-earnings sell-off, Workday's stock is currently priced at roughly 22.4 times trailing-12-month sales, and its stock price is heavily dependent on revenue growth relative to expectations. The company has done an impressive job of building sales over the past couple of years, but total expenditures have also risen because of acquisitions and other expansion costs.
Revenue has increased roughly 196%, while total expenses have increased roughly 135%, and the company's price-to-sales ratio has grown roughly 186%. Costs are increasing at a slower rate than revenue, but the extent to which the company's stock price has increased relative to sales growth may indicate that the company is overvalued. It wouldn't take big earnings misses or downward target revisions to cause major depression in Workday's share price. As the most recent earnings release indicates, even strong growth might not meet expectations. Analysts expected $205 million in revenue for the quarter, with actual sales coming in at $215 million, and representing 68% growth year-over-year. Losses were also lower than expected and revenue from subscriptions was up 75% YOY, indicating that even solid earnings results could fail to meet investor targets and trigger declines in valuation, especially as there are indications that growth may soon slow down.
Workday could be hit by security breaches
Cloud-based ERP software generally allows businesses to worry less about maintenance and product replacement, but it can also make crucial information less secure. Cloud data breaches accounted for 20% of all breaches in the third quarter of 2014, according to SafeNet, and storage security looks to be an ongoing concern.
If Workday were to be hit with a significant data breach, it could have a calamitous impact on the company's valuation. The software maker has some significant advantages against competitors Oracle and SAP AG in terms of cloud-based offerings, but the fact that these companies still provide on-site solutions could work in their favor and against Workday in the event of a security breakdown. A breach wouldn't even necessarily have to occur on Workday's network to have a significant impact on its stock; other headline-grabbing hacks could occur and damage confidence about the security of the cloud, making it more difficult for the company to grow its customer base.
What does the future hold for Workday investors?
Workday offers esteemed products in a sector that is expected to see significant growth over the next five years. Even so, it's up against formidable, resource-rich competition in Oracle and SAP, and Workday will need to deliver excellent performance to justify and grow its valuation. That's not to say that the company won't provide wins for shareholders or those who might take a bullish position at the current stock price, but investors would be wise to weigh some of the key factors that could contribute to falling valuation.
