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ServiceNow: Valuation Concerns in the Face of Strong Growth ServiceNow: Valuation Concerns in the Face of Strong Growth

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ServiceNow headquarters in Santa Clara, California, USA

When it comes to investment pitches, ServiceNow (NYSE:NOW) can certainly paint a tempting picture. With a staggering ~100% compound annual growth rate (CAGR) from 2013 through 2022, the company appears to have a strong commercial momentum and potential for further growth. ServiceNow is positioned to drive digital transformation, breaking down application and communication barriers to enhance productivity across sectors like sales, HR, and IT. Management estimates the company may address a $220 billion market, an alluring thought indeed. However, there is one big problem – its current 15x EV/Sales valuation.

My calculations, based on a residual earnings model that accounts for company fundamentals and optimistic analyst consensus estimates through 2025, point to NOW being overvalued by more than 50%. With this kind of mismatch between perceived value and actual worth, my recommendation is to assign an Underweight/Sell rating.

It’s no secret that ServiceNow stock has outperformed the broader equities market this year. Since the start of the year, NOW shares are up more than 82%, a significant difference compared to the gain of approximately 25% for the S&P 500 (SP500) and close to 56% for the tech-heavy Nasdaq 100 (QQQ).

ServiceNow: Pioneering Cloud-Based Workflow Solutions

The year 2004 saw the birth of ServiceNow, initially focused on IT service management (ITSM) and later evolving into a leader in digital transformation across various organizational functions. It now encompasses HR service delivery, customer service, and security operations, catering to the increasing demand for workflow optimization. Its cloud-based solutions are revolutionizing digital workflows, streamlining and automating business processes.

After speaking with five of the company’s actual customers, it’s evident that ServiceNow secures its competitive position through broad functionality, a user-friendly interface, scalability, and a commitment to customer-centric innovation. When it comes to ITSM, few alternative vendors offer a comparable solution, making ServiceNow a standout choice for many businesses.

Untapped Market Potential to Drive High Growth

Given its competitive standing, ServiceNow is primed to capture growth in the fast-growing cloud computing market for managing workflows – an opportunity estimated at $220 billion in 2025. The company has emphasized ample room for growth in higher-tier accounts, with its existing customer base of approximately ~8,000 falling significantly below the estimated ~50,000 potential customers. With international expansion as a key growth driver, ServiceNow’s partnerships with major system integrators and tech firms position it for further expansion.

Additionally, ServiceNow’s integration of generative AI, such as the NOW Assist feature, has resulted in notable adoption and an uplift in average selling price. This AI is expected to enhance incident deflection rates, root cause analysis, and the use of natural language for post-incident summaries and analysis, ultimately bolstering digital workflows and productivity.

Despite these positives, the 15x EV/Sales valuation is hard to overlook. It’s a steep price to pay, one that doesn’t align with the company’s actual worth. ServiceNow may be riding high on its growth, but investors should beware of the potentially perilous pitch at such lofty valuations.

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