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Upgrades: 3 Facts to Know About ServiceNow's New Buy Rating

By Rich Smith - Feb 18, 2016 at 1:05PM

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An almost unknown analyst recommends buying. What should you do now?

ServiceNow (NOW -1.51%) stock sank 39% since hitting a recent high of $90 in December. This -- despite beating analyst estimates with a stick in its January earnings report. And yet, just this morning, analysts at Wunderlich Securities came out with a new recommendation on the enterprise cloud computing software maker.

Wunderlich thinks you should buy ServiceNow. But why?

The news
According to Wunderlich, ServiceNow shares that sell for just $55 and change today are worth $75, at least. And yet, at last report the stock was flat to down despite the new buy rating.

Clearly, investors aren't giving much credit to Wunderlich's opinion. And you can't really blame them. As of this writing, not a single mainstream media outlet has any details on Wunderlich's recommendation to buy ServiceNow. This puts investors in an incredibly frustrating position. We know -- thanks to a report -- that Wunderlich thinks ServiceNow stock is a buy. We know how much they think the stock is worth: $75. But we don't have any idea why.

Here are a few things we do know, though.

Fact 1: ServiceNow's last earnings report was a blowout
As my Foolish colleague Steve Symington explained last month, ServiceNow beat analyst estimates pretty easily last quarter, narrowing its GAAP loss to $0.23 per share from $0.30 a year prior, and growing its quarterly revenues 44% year over year.

And that quarter, by the way, capped a year in which ServiceNow became "only the second enterprise SaaS company to surpass $1 billion in [annual] revenue." (Presumably, ServiceNow was referring to rival (CRM -3.96%) as being the first software-as-a-service company to pass that $1 billion threshold.)

Fact 2: ServiceNow isn't profitable...technically
Granted, revenues aren't profits, and ServiceNow didn't earn any profits at all last year. For that matter, from the standpoint of GAAP accounting, ServiceNow hasn't earned any profit in any year for the last five years. According to data from S&P Global Market Intelligence, the last time ServiceNow booked a GAAP profit from its business was mid-2011 (right before the company changed the end-date for its fiscal calendar).

But the news isn't all bad. At the same time as ServiceNow was posting GAAP losses, you see, the company was also producing large (and increasingly large) amounts of positive free cash flow. Real cash profits at ServiceNow in 2011 (under the new fiscal calendar) totaled $25 million. By last year, that number had increased ninefold -- to $228 million.

Fact 3: ServiceNow might be a bargain anyway
What do $228 million in cash profits imply for ServiceNow's valuation? Well, according to S&P Global Market Intelligence, analysts who follow this company on average expect ServiceNow to grow its profits more than 43% annually over the next five years. That's 16 points faster growth than these same analyst expect to see from

According to my extremely rough valuation guide for stocks, that implies a valuation of something on the order of $10 billion for ServiceNow stock -- or about 18% more than ServiceNow's current enterprise value. If I'm right, the stock should be worth about $65 a share, which, while not quite as big a number as what Wunderlich is positing, does at least suggest the analyst is on the right track.

And one more thing...
All that being said, and despite both Wunderlich's optimism about ServiceNow stock -- and my own -- you must understand that ServiceNow's valuation depends largely on its hitting that target growth rate of 43%. That's going to be incredibly difficult to do in the face of stiff competition from Salesforce (and others), and there's no guarantee the company will succeed.

Indeed, according to our data here at Motley Fool CAPS, most of the investors we track do not think that ServiceNow will succeed. Like its rival, ServiceNow is currently rated only a two-star stock out of a possible five CAPS stars. This implies that most of our members believe ServiceNow will not, in fact, beat the market as Wunderlich says it will.

Who will be proven right in the end? Our CAPS members or the professionals at Wunderlich? You tell us. Log on to CAPS today, and tell us what you think of ServiceNow stock.

Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 256 out of more than 75,000 rated members.

The Motley Fool recommends Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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ServiceNow Stock Quote
$487.46 (-1.51%) $-7.49
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$182.24 (-3.96%) $-7.51

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