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Netsuite (NYSE:N) is scheduled to report earnings this week. I do not think that there will be a huge sell off following the report as the industry dynamics appear to be remaining favorable.

With that said, I was looking at Netsuite as a potential long candidate on bullish industry fundamentals, but the price I would have to pay for shares of Netsuite is exorbitant. The valuations are stratospheric with a growth rate that does not justify the pricing.

Netsuite may make an excellent short sale candidate at some point, but the industry and economic fundamentals remain bullish. There is evidence of bullish fundamentals throughout the report; the problem with Netsuite is the valuations.

Recent Developments

  • IDC predicts spending on cloud IT services will grow at a compound annual rate of 26.4% between 2012 and 2016.
  • Netsuite entered into an agreement to acquire TribeHR, a leading provider of Human Capital Management solutions. With this acquisition, Netsuite's product offerings more closely resemble Workday's product offerings.

Relative Performance

% Total Return1-Month3-MonthsYTD1-Year
N0.5616.0161.0080.98
WDAY0.3018.8648.9546.93
CRM4.4429.6531.1147.91

Netsuite is clearly outperforming its software as a service competitors, which leaves the firm relatively overvalued.

Fundamental Analysis

Netsuite competes in the software as a service category, which is a growth industry.

Cloud based software as a service offerings are being purchased by businesses of all sizes at a rapid pace as on-premise deployments are replaced and new customers enter the market.

I forecast the technology to continue to penetrate the market. Consequently, the industry dynamics should remain favorable for at least the next two years.

The favorable industry dynamics are reflected in the revenue growth rates of Netsuite, salesforce.com (NYSE:CRM), and Workday (NYSE:WDAY).

Netsuite's 5-year average revenue growth rate is 23.26% with growth accelerating recently to the low-to-mid 30% range.

Salesforce.com's revenue growth rate is in the low-to-mid 30% range, but is not showing signs of accelerating revenue growth.

Workday is the fastest growing of the three companies with a revenue growth rate that is north of 50%.

From a valuation perspective, Netsuite at 22.0 times trailing sales is selling at more than twice the price of salesforce.com. Workday is selling at an exorbitant 32.7 times trailing sales.

On a price to book basis, Netsuite is almost twice as expensive as Workday, which trades at 22.1 times book. Salesforce.com is the cheapest at 11.7 times book.

Combining the valuations and the growth rates, Netsuite is relatively overvalued.

Additionally, salesforce.com has the highest gross margin of the three companies; if all else were equal, salesforce.com would be the most profitable of the firms.

Portfolio Management

Netsuite is trading in secular, primary, and intermediate term bull markets. This means buying opportunities are shallow throwbacks. Prudent risk management dictates tight risk-based trailing stop loss orders. The technicals are bullish.

From a portfolio perspective, since March of 2009, the share price of Netsuite has increased at a compound monthly growth rate of 4.2%. The return distribution is positively skewed and is not leptokurtic. Using the upper band of the trend forecast, the 52-week price target is $105.60, which means that Netsuite is trading above trend.

The secular bull market leaves shares of Netsuite overvalued in the market. Investors should not be long this stock. (Salesforce.com could be an excellent long candidate.)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Netsuite: Bullish Fundamentals, But Bearish Valuations