ServiceNow stock (NOW) has been on a roll recently, boasting over 55% one-year returns, comfortably outpacing the S&P 500. While many are still bullish on further upside in the stock, we believe it’s time to sit on the sidelines and enjoy the profits.
ServiceNow specializes in digital workflow automation, providing cloud-based workflow automation solutions that help organizations improve their operations. Its single data model that integrates various business functions into one platform is what makes this company unique because it boosts operational efficiency across departments.
The company’s main product is the Now Platform, which integrates multiple functionalities into a single platform, enabling seamless collaboration and data flow across different business units, and allowing users to build custom applications for their specific needs.
The rest of ServiceNow’s solutions allow organizations to automate their IT processes, improve employee interactions with human resources departments, manage security incidents, and enhance customer support and service interactions.
Approximately 95% of ServiceNow’s revenue comes from subscription fees for its cloud services. From a geographic point of view, North America is the largest contributor to revenue generating 63% of the total, while Europe, the Middle East, and Africa contribute 25%.
Some of its top clients are Accenture, Adidas, NASA, KPMG, Vodafone Group, Siemens, Cengage Group, and Epicor Software Corporation.
Our bearish thesis on the stock stems from two important factors: Carahsoft’s troubles with the Department of Justice and stock valuation.
Carahsoft is alleged to have engaged in price fixing for products sold to the US government. While ServiceNow isn’t directly named in the investigation, it is an important partner of Carahsoft. Its reliance on the US government for over a billion dollars in revenues has put a big question mark on the company’s future relations with the government.
In a best-case scenario, the company would get away with a fine. Worst case, their future revenues from the government become doubtful. This uncertainty is going to weigh on the stock price which is close to all-time highs, meaning there is room for a significant correction.
This also brings us to the question of valuation. Being at an all-time high doesn’t necessarily make a stock overvalued. However, at 59 times its free cash flow per share, the stock’s valuation is definitely high. Microsoft for instance trades at over 41 times its free cash flow per share. Granted ServiceNow can grow at a higher rate because of its small size. But is it really worth that risk? We don’t think so.
ServiceNow ranks 24th on our latest list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 97 hedge fund portfolios held NOW at the end of the second quarter which was 90 in the previous quarter. While we acknowledge the potential of NOW as a leading AI investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is as promising as NOW but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article was originally published at Insider Monkey.