Is ServiceNOW Stock Overvalued?

ServiceNow Inc (NYSE:NOW) is a California-based platform-as-a-service (PaaS) company that helps enterprises manage their workflows. The company’s services became essential digital tools when shutdowns forced businesses to go virtual to attract customers.

The company rocketed higher on soaring revenues and earnings expectations which has some analysts musing is ServiceNow stock overvalued?

The company used its increased revenue to acquire several artificial intelligence (AI) companies throughout 2020, including Loom Systems, Passage AI, and Element AI. Integrating AI into its cloud-based platform gives it an edge in enterprise technology.

AI and cloud computing were on the rise long before the pandemic. The forced online migration merely accentuated their need and accelerated the industry’s growth. With companies like Salesforce, SAP, and Microsoft (MSFT) nipping at its heels, is ServiceNow set to thrive or nosedive?

Why ServiceNOW Stock Went Up

ServiceNow CEO Bill McDermott took the reigns in November 2019. He barely had his feet wet when NOW share price crashed in tandem with the stock markets and changed the business landscape.

The company has a long-standing relationship with video conference software Zoom (ZM). So, when Zoom went up, ServiceNow did too.

Of course, that wasn’t the only reason.

By the third quarter of 2020, the company had 1,012 customers locked into long-term contracts worth over $1 million each. ServiceNow clients include federal and state governments, along with the NBA, Dell (DELL), and more.

This gives the company twice as many clients as it had at the same point the prior year. That led McDermott to declare the digital transformation in business. And NOW stock price grew like gangbusters, powering well above the $500 Buy point set by analysts.

That corresponded to a market capitalization well over $100 billion, which led some to wonder if ServiceNOW has the financial strength to sustain its growth curve. Examining its books gives a clue as to what the future will hold.

ServiceNOW Earnings Are Projected To Soar

What has analysts and investors most excited about is future earnings and revenue projections. ServiceNow earnings per share estimates for the coming fiscal year are rising like a straight line.

That’s not a pattern you can expect even from a heavyweight like Amazon (AMZN), which has a more seasonal pattern of spikes and dips connected to consumer spending.

Its 2020 Q3 earnings report showed $1.091 billion in subscription revenues and a 98 percent renewal rate.

Year-over-year growth was 29 percent, and the company has over 6,000 total customers each year.

From a valuation perspective, it appears investors have caught on to the good news story. ServiceNOW P/E ratio of around 150x is extremely high when compared to SAP’s 25x or Salesforce’s 50x ranges. It pales in comparison to Zoom’s 250x valuation, but it still shows there are higher investor expectations for ServiceNow compared to its competition.

That has some bearish investors wondering if its valuation is too high.

Is ServiceNOW Valuation Too High?

Most analysts complained in 2019 that ServiceNow was already overvalued. At the time it breached a 50x P/E ratio, which was enough to raise concern among investors. Thereafter investors went on a buying spree for technology stocks, and ServiceNOW catapulted higher from a share price and valuation perspective.

Soon fears grew of a technology bubble that echoed the dotcom bubble of the late 1990s. It’s unclear how well “pandemic stocks” – which are predominantly tech stocks like ServiceNow – will perform if and when there is a return to normalcy.

Many experts agree that the Fourth Industrial Revolution is already underway. Instead of changing the way we live, the COVID-19 outbreak merely accelerated our technology’s natural progress and evolution. Delivery services, contactless payments, and video conferencing were already in place. Workflows were in place.

For investors a huge attraction to the company is the 1,000+ B2B contracts in place help them to predict revenues more easily than other industries. This gives it an advantage that may justify its high price.

Still, it’s overvalued when compared to competitors, and it will need to show continued growth over the next year to quell any fears of the price dropping.

Will ServiceNOW Stock Drop?

NOW stock mostly outperformed the stock market in 2020, backed by strong earnings reports and growth as companies converted to a digital business model. The company is a key ingredient in bringing automation aspects of the industrial revolution from the supply chain into business operations.

This makes the platform a valuable weapon for companies to integrate their systems. Businesses large and small often use dozens to hundreds of proprietary platforms. As the business grows through mergers and acquisitions, even more technology is thrown into the mix. IT department spending can balloon when so many specializations are required.

But that doesn’t make ServiceNow immune to market conditions. It has strong competition from the likes of Salesforce, SAP, and Microsoft (MSFT). Amazon (AMZN) and Google (GOOG) are steadily increasing their cloud-based tools too.

Artificial intelligence is at the bleeding edge of high technology. By investing in AI companies, ServiceNow strengthens its technological advantage exponentially. If a tech bubble reaches its ceiling, the company could bail itself out by merging or possibly even acquiring Zoom, which many analysts feel is ripe for acquisition.

Either way, ServiceNow is bound to have turbulent share price blips. It could temporarily fall, but even the coronavirus pandemic only held it down until it released an earnings report. Strong company ties and a focus on advanced technology should keep it afloat for decades to come.

Is ServiceNOW Stock Overvalued? The Bottom Line

ServiceNow is a PaaS company that builds AI-assisted workflow solutions to bring companies into the latest digital age. It serves major clients in both government and commercial settings with long-term contracts in place that should keep cash coming in for years to come.

Being in the right place at the right time pushed NOW stock beyond the P/E ratios of similar competitors. This lofty valuation could signal that a new tech bubble is ballooning to its limits. That could leaving many late-in-the-day investors shortchanged as the economy reopens in full force.

ServiceNow and Zoom are two companies fighting much larger competitors who outperformed many of them by using each other’s tools. Should they merge, it could be a powerful enough combo to dodge the bubble burst.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.