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I do not currently have exposure to ServiceNow (NOW) and I have never previously analyzed it. Given that it released its Q4 and FY2023 results and FY2024 outlook on January 24, I take this opportunity to analyze this company.
In June 2012, ServiceNow (NOW) became a publicly traded company following a US$0.21B IPO. Since such time, it has generated an Average Annual Total Return just shy of 35%. While impressive, this historical rate of return doesn't mean much unless an investor initiated a position as the time of the IPO and NEVER sold shares.
However, how many retail investors fall in this group? I suspect very few.
In all probability, many retail investors initiated a position during COVID when day trading helped people while away the days. Some may have made money. Many most likely lost money because they acquired grossly overvalued shares and then panicked when NOW's share price capitulated a little over 50% after it peaked at ~$700 in late October 2021; the share price dropped steadily to ~$342 in October 2022.
Unless an investor had the intestinal fortitude to retain shares that were acquired when they were grossly overvalued, a NOW investment would have resulted in a loss.
Fast forward to January 29 2024, and NOW's current share price as I compose this post is ~$789. If an investor bought shares at in late 2021, the investment return is nowhere close to ~35%.
I mention all this to demonstrate how critically important it is to pay attention to a company's results and valuation. Making investment decisions solely on share price behavior is a recipe for poor investment returns.
In this post, I look at NOW's current valuation to determine if this is a good/not good time to initiate a in the FFJ Portfolio.
Business Overview
Investors unfamiliar with NOW should review the company's website and Part 1 Item 1 within the FY2023 Form 10-K.
Another key document to review is the company's Proxy Statement. The 2024 Proxy Statement is likely to only be released in mid-April 2024. Until such time, the 2023 Proxy Statement must be relied upon.
When reviewing the Proxy Statement, it is important to determine if the Executive Compensation Program is structured to be closely aligned with shareholder interests.
Your investment in a company should be made from the perspective that you are a business owner. As a business owner, you should not be thinking about actively trading your ownership interest. Instead, you should be approaching your investment with the intent of holding shares for several years. You, therefore, want to ensure executive compensation is structured so that decisions are made with the company's long term success in mind. Naturally, short and medium-term decisions are also important. Failure to pay attention to the short and medium-term could lead to NO long-term.
Financials
Q4 and FY2023 Results
I can not possibly cover all the Q4 and FY2023 material in this post. I, therefore, provide links to NOW's Q4 2023 Earnings Release, Earnings Presentation, and FY2023 Form 10-K for ease of reference.
Source: NOW - Investor Fact Sheet
Looking at NOW's Consolidated Statements Of Comprehensive Income (page 57 of 103), we see that it generated $8.42 in diluted EPS versus $1.13 and $1.60 in FY2021 and FY2022. In FY2023, however, it had a net tax benefit of $0.723B while in FY2021 and FY2022 it had to make a $74 million and a $19 million provision.
NOW also reported $65 million of Other comprehensive income (Foreign currency translation adjustments and Unrealized gains (losses) on investments, net of tax) in FY2023 versus Other Comprehensive Losses of $60 million and $132 million in FY2021 and FY2022.
While NOW's Cash and cash equivalents, Short-term investments, and Long-term investments are higher than prior years, it benefited from the rising interest rate environment; NOW reported Interest Income of $302 million versus $20 million and $82 million in FY2021 and FY2022.
Operating Cash Flow (OCF) and Free Cash Flow (FCF)
NOW's OCF and FCF in FY2014 - FY2023 (in millions of $) is:
OCF: 141, 318, 159, 643, 811, 1,236, 1,786, 2,191, 2,723, and 3,398.
FCF: 87, 229, 35, 486, 562, 898, 1,354, 1,799, 2,173, and 2,704.
FY2024 Guidance
NOW is raising its FY2024 outlook to reflect the early success it is witnessing with its Generative AI products.
Source: NOW - Q4 and FY2023 Earnings Presentation - January 24, 2024
Credit Ratings
On January 24, 2024, S&P Global reiterated NOW's A- senior unsecured domestic long-term debt rating with a stable outlook.
On March 15, 2023, Moody's upgraded NOW's senior unsecured domestic long-term debt rating from Baa1 to A3- with a stable outlook.
Both ratings are the lowest tier of the upper medium-grade category. They define NOW as having a strong capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
Both ratings are investment grade and are acceptable for my purposes.
Dividend and Dividend Yield
NOW does not currently distribute a dividend.
NOW's weighted average number of issued and outstanding shares in FY2014 - FY2023 (in millions rounded) is 145, 156, 165, 171, 178, 197, 202, 203, 204, and 206.
In May 2023, NOW's Board authorized a program to repurchase up to $1.5B of common stock. During FY2023, NOW repurchased 0.9 million shares of its common stock for $0.538B. All repurchases were made in open market transactions. As of FYE2023, $0.962B of the originally authorized amount remained available for future repurchases.
Valuation
NOW's PE has historically not been a good metric by which to gauge its valuation because it reported GAAP losses in FY2014 - FY2018 and negligible income in FY2020 - FY2022.
Looking at NOW's PE in FY2019 - FY2022, we see this valuation metric was 1,568.44, 155.49, 595.51, and 392.19!
Since the PE was an inappropriate metric to determine whether to invest in NOW, let's see how NOW fared from a P/Cash Flow perspective. During the FY2014 - FY2021, NOW's P/Cash Flow was 76.11, 51.38, 92.28, 37.41, 44.45, 49.21, 72.97, and 64.64. More realistic but still very high!
The weighted-average shares used to compute net income per share in FY2023 was 205,591 million. On the Q4 earnings call, management stated it expects GAAP diluted weighted average outstanding shares of 208 million.
Let's presume the company's FCF increases by ~$0.8B to ~$3.5B (rounded). The FY2024 FCF per share is then ~$16.83.
Shares currently trade at ~$788 thus resulting in a ~46.8 forward Price/FCF per share.
If NOW's share price were to plunge to $650, the forward Price/FCF per share is ~38.6.
The forward adjusted diluted PE levels using current broker forward adjusted diluted EPS estimates are:
- FY2024: 36 brokers, mean estimate $13.19, low/high range $12.22 - $14.39. The valuation using the mean estimate is ~60.
- FY2025: 34 brokers, mean estimate $15.98, low/high range $15.32 - $18.15. The valuation using the mean estimate is ~49.
- FY2026: 15 brokers, mean estimate $19.74 low/high range $17.85 - $22.90. The valuation using the mean estimate is ~40.
If we use a $650 share price and the same broker mean estimates reflected above, the valuation estimates would be:
- FY2024: ~49
- FY2025: ~41
- FY2026: ~33
ServiceNow - Final Thoughts
Warren Buffett and Charlie Munger have often stated:
It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
They didn't say to buy a wonderful company at ANY price.
NOW might be a wonderful company. It is profitable, generates strong FCF, has strong recurring revenue, gets paid from customers BEFORE providing services, etc.. However, the whole point of investing is to generate a decent rate of return while ensuring risk is within your risk tolerance.
You might generate a decent return over the long-term if you acquire NOW shares at the current valuation. The moon and the stars, however, had better line up perfectly because a hiccup could lead to investors heading for the exits.
At the beginning of this post I showed how NOW's share price plummeted a little over 50% within a span of one year. Could this happen again? Of course! Generally, shares prices do not increase in perpetuity. If you look at the stock charts of great companies over the very long-term, it may appear that their stock price never 'corrects'. Zoom in over shorter time frames, however, and you will likely see stock price fluctuations.
In my opinion, NOW's share price behavior is representative of this. It has surged of late and a pullback is certainly not out of the question if/when investors realize that paying ~$60 for $1 of adjusted earnings or ~$40 for $1 of FCF is a little ridiculous.
I do not currently have NOW exposure in the FFJ Portfolio nor in any retirement accounts for which I do not disclose details and am certainly not about to acquire shares any time soon. If the share price were to plummet as it did in 2022, I would revisit this company to determine whether or not to invest in it. For now, however, I prefer to patiently wait for investor euphoria to die down.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I do not have exposure to NOW and do not intend to initiate a position within the next 72 hours.
Disclaimer: I do not know your circumstances and am not providing individualized advice or recommendations. I encourage you not to make investment decisions without conducting your research and due diligence. You should also consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
