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Splunk: A Good Short-Term Investment

- By Ishan Majumdar

As the U.S. markets experienced one of the worst sell-offs within the technology space over the past three months, a number of companies are excellent bargains, and growth investors are evaluating the best tech buys at the current levels.

Splunk Inc. (SPLK) is one of the beaten-down tech stocks with a fantastic growth story that is worth evaluating. The company's stock has fallen by more than 16% in the past three months and was down from the 52-week high of $130 to below $100 a few weeks back. The stock has begun its recovery, and the current level is a suitable entry point.


A solid third quarter but weak revenue guidance

Splunk has a diverse range of offerings in the field of data management and analytics: cloud solutions, IT service intelligence, enterprise solutions, user behavior analysitcs, machine learning solutions, and so on. Over its 15 years of operations, the company has a diversified client base across sectors such as financial services, telecom, retail, media, healthcare, e-commerce, and many more. It has been investing most of its funds in increasing the software solutions and growing the team which is now approximately 3,200 employees.

CEO Douglas Merritt's growth-focused strategy has worked out well, with revenues consistently growing over 30% and software revenues growing more than 40%. There has been some margin improvement as well, and the percentage of losses is declining. But the main reason the company's stock lost its value was because it guided for revenue growth of only 20%, which is well below its current growth percentage.

A reduction by the guru Ron Baron (Trades, Portfolio) during the third quarter added to the bad news. But, it must be highlighted that the company is going strong in its cyber security monitoring department and with the emergence of IoT, there is much potential for Splunk's offerings. The company has gradually transitioned to a retainer model for its software solutions, which is providing solidity in revenues and improving the business fundamentals.

Fundamentals are mediocre but the valuation is better than before

Splunk has always been a typical fast-growing tech company that has never achieved a positive bottom line as a result of its focus on revenue growth. The company has an operating margin of -19.34% and a return on equity as low as -29.76%.

The only metrics worth highlighting are the revenue growth and the Ebitda growth. The three-year revenue growth rate of 34.10% is perhaps the biggest reason why the stock is being valued at such a premium. Also, the Ebitda margin has expanded by 3.50% in the past three years, and there has been a constant improvement in the operating margin as well as the earnings per share. It is a matter of time before the company turns profitable. This is the reason why Splunk is trading at 9.57 times its total revenues and 65.79 times its forward earnings.

Splunk's three-year stock price chart shows that the company has something to offer investors despite the high valuation multiples. The stock has appreciated by about 90% over the past three years, providing excellent returns to shareholders. An interesting observation in the chart is that the price has consistently followed the trend of the revenue and earnings per share estimates. The recent drop in September was evidently the result of the poor revenue growth estimate, but the chart shows that there is some room for growth. If the price line can climb back to the level between the revenue and earnings per share as it has done in the past, Splunk could easily provide a 20% appreciation from its current levels.

Conclusion

Splunk is not a stock for the risk-averse investor. It is more of an opportunistic investment for an investor looking to capitalize on the market reaction to the weak revenue guidance with the hope that the management continues to outperform and delivers good revenues along with a further improvement in margins. The recovery of the stock after the fall has already begun, and it is a matter of time before it climbs back to its earlier levels.

Disclosure: No positions.

This article first appeared on GuruFocus.