Unlike many data and cloud equities, Splunk (NASDAQ:SPLK) stock has struggled in recent weeks. The shares of the developer of Splunk Enterprise, a data analysis solution, have dropped amid worries about its acquisitions and concerns about its cash flow.
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However, by buying Splunk stock at these levels, traders may get something they do not expect from data and cloud stocks today: a discount.
Many of the stocks in those sectors seem to do nothing but move higher. Given the performance of many of Splunk’s peers, one might think that all of the stocks in the sector, including SPLK, keep making 52-week highs and have achieved outlandish price-earnings (P/E) ratios.
However, many data and software-as-a-service (SaaS) firms such as Salesforce (NYSE:CRM) and SAP (NYSE:SAP), have fallen below their 52-week highs. But those companies have not fallen as far as Splunk stock. While CRM stock has dropped by about 9% and SAP has retreated around 15%, SPLK stock has tumbled more than 18% below its 52-week high.
Why Splunk Stock fell
One reason for the decline of Splunk stock was concern that its acquisition of SignalFx would dilute the shares. That feeling likely worsened after SPLK announced earlier this month that it would also buy Omnitron. There is some uncertainty as to how these deals will affect the cash, debt, and shares outstanding of SPLK.
Moreover, like Autodesk (NASDAQ:ADSK) in recent years, SPLK has begun to switch from a permanent license model to a subscription revenue model. Although the change should result in SPLK generating more revenue over the long-term, such a decision usually leads to a temporary reduction of cash flow.
In the wake of fears about its acquisitions, Splunk stock has tumbled from its $143.70 per share high in mid-July to about $116 per share today.
However, I see the moves made by SPLK as positive. Many commentators will often criticize firms for putting their short-term profits ahead of their longer-term needs and those of their shareholders. In this case, in an effort to improve its offerings, SPLK has bought other companies. It also switched to a subscription revenue model that should increase its cash flows over the long-term.
Still, instead of rewarding the company, traders briefly took SPLK stock into bear-market territory. I believe that the unjustified decline of Splunk stock has created a good buying opportunity.
The Case for SPLK Stock
The forward P/E ratio of Splunk stock may look high, compared to the S&P 500’s average forward P/E ratio. Still, given the high expected growth of Splunk’s future earnings, the forward P/E ratio of Splunk stock, which currently stands at 49, looks reasonable. For fiscal 2019, analysts, on average, expect Splunk’s earnings to jump 43.6%. In FY20, analysts, on average, predict that its profits will surge nearly 25%.
Moreover, yesterday SPLK stock rose by more than 2% after JPMorgan’s Mark Murphy upgraded the shares to an “overweight” rating. Thanks to the reduction in the stock price, he sees Splunk stock as attractive. Murphy has placed a $130 price target on SPLK.
Like Murphy, I think there are reasons why Splunk’s rapid growth should continue. For one, all things cloud are still growing almost exponentially. Moreover, as InvestorPlace columnist Luke Lango noted, “more and more customers are leaving bigger and bigger digital footprints.” Consequently, SPLK remains well-positioned to expand its customer base at a rapid pace.
Investors should also note that the price-sales ratio of SPLK is 8.6, well below the shares’ average P/S multiple of the last five years, which is 11.4.
The Bottom Line on Splunk Stock
The JPMorgan upgrade highlights the buying opportunity created by the weakness of Splunk stock. Although buying companies and switching to subscription-based plans will hurt SPLK in the short-term, the moves should improve its performance over the longer term.
The weakness of SPLK stock gives traders the chance to buy this growth name at a below-average multiple. Investors should take advantage of this opportunity and consider using any additional pullbacks of SPLK stock to buy the shares at an even larger discount,
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
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