What: Shares of enterprise software provider Splunk (SPLK -9.60%) surged during March, rising 12.2% according to data provided by S&P Global Market Intelligence. Splunk reported earnings in late February that drove the stock higher, but the gains in March appear to be driven by two post-earnings analyst upgrades.
So what: Shares of Splunk jumped after the company handily beat analyst estimates on Feb. 25, with the company growing revenue by nearly 50% year over year. Guidance was also strong, with Splunk beating analyst estimates for first-quarter and full-year revenue.
On March 4, Keith Bachman of BMO launched coverage on Splunk, starting with an outperform rating and a $55 price target. Bachman expects security revenue to grow by 40% in fiscal 2017, along with 11% annual growth in the company's addressable market. He also believes that billings during fiscal 2016 understate the company's true growth, and that competition from privately held Elastic isn't a serious threat.
Bachman states that Splunk's valuation is reasonable based on expected free cash flow in fiscal 2018, with the analyst putting the ratio of enterprise value to expected free cash flow at 26. On March 22, Stifel followed suit by increasing its price target on Splunk by $5 to $56 per share, reiterating its buy rating.
Now what: There's no question that Splunk is growing fast, and the company is free cash flow positive, generating about $104 million in free cash flow in fiscal 2016. But the stock trades for about 10 times sales, and on a GAAP basis, the company lost $279 million last year. Furthermore, Splunk's positive free cash flow is entirely due to the company's use of stock-based compensation and its rising deferred revenue balance.
Despite the continued losses, investors pushed shares of Splunk higher during March, valuing the company based only on revenue growth. As long as Splunk can keep up its rapid rate of growth, there's nothing keeping the stock from going higher. But if growth starts to slow down, watch out below.