Shares of cloud tech company Splunk (NASDAQ:SPLK) are up more than 75% year-to-date, handily outperforming the S&P 500’s average return of 19%.
Much of this gain occurred when the stock spiked following the company’s Q3 earnings report, giving existing shareholders a very healthy return on their money. The question now, though, is whether Splunk stock is still a good buy at today’s elevated prices.
Splunk is a cloud services and software company that focuses on cybersecurity solutions. It specializes in cloud observability and threat detection, allowing businesses to monitor their digital assets and move quickly to address issues. It’s also incorporated generative AI into its offerings by creating AI-powered assistants to help human users.
So far, customers have reacted well to the product evolution. On November 28th, Splunk reported Q3 results for its 2024 fiscal year and delivered impressive revenue growth, up 26% year-over-year to $1.07 billion.
Peeking Under The Hood Explains The Success
The main driver of this growth was the cloud services segment, which increased from $374.0 million in the year-ago quarter to $469.4 million. Revenue also beat out the analyst consensus estimate of $1.03 billion.
So too, annualized recurring revenue (ARR) was a bright spot that reflected strong growth in the company’s overall business, rising by 15% to 4.0 billion.
As of the end of the quarter, Splunk had 851 customers contributing $1 million or more in ARR.
Earnings were also up, with Splunk reporting diluted net income of $0.55 per share. Like the top line, the bottom line substantially beat out analysts’ consensus estimates. It also represented a massive improvement over the same quarter in 2022 when Splunk lost $0.20 per share.
Year to date, Splunk has lost $0.98 per share, compared to $3.38 in the same period last year. This trend of improving earnings is expected to continue for much of the next half-decade. The 5-year projected earnings growth rate for Splunk is 27.7%.
Operating cash flow is also forecast to more than double over the next year alone, giving current Splunk shareholders much to look forward to.
While the most recent quarter was unexpectedly successful, it’s worth acknowledging that Splunk has delivered excellent revenue growth over many years. In Q3 of 2013, it was reporting a comparably low $67 million in total revenues. Fast forward a decade and that number has jumped to well over $1 billion. Even more impressive is the fact that revenue has grown on a year-over-year basis in all but three quarters over the last 10 years.
There are, however, still areas in which Splunk’s performance needs improvement. One of these is net margin. Over the last 12 months, the company’s total net margin has been 2.7%. While this number is trending higher and allowing Splunk to reach profitability, management will need to improve profitability if the stock’s current momentum is to be sustained.
Is Splunk Stock Undervalued?
Having spiked after the last earnings report, Splunk shares may not have much room left to run.
Splunk is overvalued by 3.0% according to the consensus estimate of 26 analysts who assess fair value at $144.83 per share.
The range of estimates is from a low of $105 per share to a high of $162 per share. What’s even more interesting is that Splunk managed to make the list of both the most upgraded and most downgraded stocks as analysts adjusted their ratings after the company’s quarterly report.
At 128x book, 40x forward projected earnings and 322x cash flow, Splunk stock is certainly no bargain at today’s prices.
Sure, if earnings grow at the rate expected by analysts over the next five years, Splunk could deliver at least decent returns, but for now, barring further upside earnings surprises it seems that Splunk is trading at a more or less fair value.
Is Valuation Bloated Now?
With sky high expectations following the most recent earnings report, a bloated valuation is arguably the biggest concern for current shareholders. While management has delivered one quarter of significantly better-than-expected performance, the trend will have to continue in order for Splunk to justify its current valuation.
Another major concern for Splunk is its sky-high debt-to-equity ratio of 15.6. The company has borrowed heavily in recent years, running up a long-term debt of over $3 billion.
Although Splunk has managed to pay some of this down over the past year, the high levels of debt behind the company’s growth could be worrisome for investors. This is especially true if Splunk is forced to resort to further borrowing in today’s interest rate environment.
Finally, Splunk is operating in an increasingly competitive cloud services marketplace. Its competitors include the likes of Datadog, Amazon Web Services and Microsoft Azure.
While Splunk’s stable of high-value customers contributing large amounts to the company’s ARR gives it some protection, there is little doubt that competition for cloud cybersecurity service dollars will continue to be intense for the foreseeable future.
Is Splunk a Buy?
With excellent revenue growth, a strong customer base and existing profitability, there’s much to like about Splunk’s financials. The high rate of expected forward earnings growth is a future tailwinds that should support higher valuations. But today’s prices are lofty.
The run that followed the most recent earnings report brought SPLK share price toward the upper end of what could be considered a fair value range, and then some. As such, investors who buy today may have very little margin of safety. Any mis-step in earnings or revenue growth could be severely punished now, creating a worrisome scenario for new buyers.
For those who own a portion of the company now and have enjoyed a good run, it’s hard to argue Splunk is a sell, but equally the elevated valuation doesn’t justify a Buy. The bottom line is a Hold rating at this time is most appropriate.
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.