ServiceNow Set To Move Higher After Third Quarter Earnings Report

About: ServiceNow (NOW)
by: Rick Pendergraft

The enterprise software company reports earnings Wednesday after the closing bell.

The stock has gained 275% since its 2016 low.

Analysts love the stock, but short sellers are pessimistic toward it.

Software provider ServiceNow (NOW) has been a top performing stock in the last couple of years. The company provides enterprise cloud computing software that helps clients define, structure, manage and automate services.

The Santa Clara-based company is the number one ranked stock in the software enterprise group by Investor’s Business Daily. When the company releases earnings after the close on Wednesday, investors want to know if it is maintaining its pace of growth.

Over the last three years, ServiceNow has averaged earnings growth of 108% per year while sales grew by 39% per year. In the last earnings report, earnings grew by 123% and sales grew by 41%. Analysts are predicting earnings growth of 75% for 2018 as a whole and sales growth of 34.3%.

The company shows a current return on equity of 46.8% and a profit margin of 17.7%.

ServiceNow is a growth company and that leads to a few negatives on the stock. The current P/E ratio is one concern, at 100. Another small concern is the $857 million in debt. The company currently has over $1.76 billion in cash and equivalents, which explains why the debt isn’t a bigger concern.

Analysts expect the company to earn $0.60 on revenue of $657.7 million. The consensus estimate on the EPS is up a penny over the last 30 days. The revenue estimate is 32.3% higher than the revenue from the third quarter of 2017. The revenue growth has been a key factor in how the stock has performed in recent years.

NOW Gained Almost 350% in Two and a Half Years

While the company has been growing sales and earnings, the stock has been rising at an incredible pace. From February of 2016 through the high in September, ServiceNow’s stock price gained just shy of 350%. The stock has slumped in the last couple of months, but it is still above its long-term moving averages.

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We see on the weekly chart that the recent pullback has only trimmed about 16% off the stock price and the 52-week moving average is still approximately 7% below the current trading price.

One positive to the recent pullback is that it has brought the 10-week RIS down below the 50 level for the first time since April 2017, and it reached its lowest level since late 2016. The stock was hovering between $70 and $80 at that time.

The weekly stochastic readings moved out of overbought territory on this latest pullback and they are reaching their lowest levels since December ’16. Once the stochastic readings made a bullish crossover back then, the stock was off to the races.

Analysts Love ServiceNow, But Short Sellers are Pessimistic

Looking at the sentiment toward ServiceNow we see mixed signals from the different groups. There are 34 analysts covering the stock and 30 of them have the stock rated as a “buy” and the remaining four rate the stock as a “hold”. That is one of the most optimistic groupings I have seen recently, but given the company and the stock’s performance it isn’t surprising.

One indicator that is surprising is the short interest ratio. The ratio stands at 4.84 currently and that is actually down from a reading of 5.53 in mid-September. That is surprisingly high for a stock that has been steadily climbing and for a company displaying the growth that ServiceNow has shown.

Option traders aren’t showing as much pessimism as short sellers, but the put/call ratio is skewed to the pessimistic side. There are currently 21,510 puts open and 26,016 calls open, putting the put/call ratio at 0.827. The put/call ratio is a little higher than it was on July 25 when the company last reported earnings. I would have expected a lower put/call ratio given how well the company and stock have performed.

What I Expect from Earnings

I think ServiceNow’s pullback in the last few months is a buying opportunity. The company’s earnings and sales growth are very attractive and the short interest ratio makes me think the rally is far from over.

Looking at the past earnings results, the company has beaten estimates in three of the last four quarterly reports, but the reactions haven’t been positive each time they beat. The company beat in July and the stock moved up 4.6% the day after earnings, but then dropped 8.5% in the next three days. In April the company beat estimates by a wide margin—$0.56 actual vs. $0.37 estimate. The stock did move up over 12% in the next two weeks.

Even when the company missed in January, the stock didn’t react all that violently. It was considerably more volatile, but that was right when the market was dropping sharply.

ServiceNow has an impressive global client list and a diversified product roster. This insulates the company from slumping growth in certain segments and from the global trade disputes that have affected many tech companies.

Given the way ServiceNow has had rather muted reactions to its earnings reports in the past, even when they missed estimates, I think you can buy the stock before earnings and not have to worry too much. I think the odds of a move higher are greater than a move lower after earnings.

If you are more risk averse and would like to wait for a signal that the pullback is over, you could use a bullish crossover from the stochastic readings as the trigger point on a bullish trade.

However you decide to play ServiceNow, I look for the stock to move significantly higher in the coming months.

Disclosure: I/we 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.