💼⚙️Business Overview

🎯Key Metrics

Total: 7/17

• +2 ✅✅ Projected Operating Margin: 32.61%
• +1 ✅ Projected 5-Year Revenue CAGR: 16.23%
• +1 ✅ Last 5-Year ROIC: 14.21%
• +1 ✅ Estimated Cost of Capital: 10.03% (less than ROIC)
• -1 ❌ Last 5-Year Shares Outstanding CAGR: +0.73%
• +1 ✅ Projected 5-Year EPS CAGR: 16.27%
• +0 ⚠️ Projected 5-Year Dividend CAGR: N/A
• +1 ✅ Estimated Debt Rating: A2
• +2 ✅✅ Morningstar Moat: Wide
• -1 ❌ Morningstar Uncertainty: High

📈ServiceNow has stellar operating margins and solid revenue and EPS growth. Also, the fact that it is able to return (ROIC) above its estimated cost of capital is nice to see.

📉There’s some uncertainty around the SaaS industry currently given AI. This could disrupt in some way the business of this company, but I need to understand it a little bit more to have an opinion formed about it. Also, the company has been dilluting its shareholders during the last couple of years, but it can be easily justified by the need to expand growth.

Given all of this, let’s check its current valuation to see if its market price is justified.

📝Business Valuation

To calculate the intrinsic value of the company I’ll use multiple methods:

• Discounted Cash Flows (DCF) – Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value using the estimated cost of capital;
• EPS Growth – the fair value is estimated by projected the Earnings Per Share CAGR for the next 5 Years and then, given its current and historic values of PE, come up with a PE for the 5th Year. This will give us its price 5 Years from now using the formula: Price = EPS x PE that we then discount using the estimated cost of capital;
• Historical P/S – we assume mean reversion to the historical P/S values.

Cost of Capital

I’ve used the latest annual financial statement of the company, the 10-Year US bonds as the risk free rate and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity. Also, given the fact that Moody’s does provide a rating for the company I used it as well.

Cost of Capital: 10.03%.

This value will be used later as a discount rate in the valuation methods.

Please feel free to come up with your own values by using the tool I’ve used: Cost of Capital – The Fair Value Journal. It is and will ever be completely free 🙂

Discounted Cash Flows (Weight: 45%)

I’ve used the latest annual financial statement of the company, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

Some notes on the inputs above:

• Terminal Revenue Growth – I’m using the risk-free rate (10-Yr bonds of the US), because long term the company should not grow more than the rate of the economy. I’m using the risk-free rate as a proxy to it, so the terminal growth becomes it;
• Terminal Cost of Capital – I’m assuming long term the cost of capital will converge to the industry average;
• Initial and Terminal Tax Rate – Given the volatility of the effective tax rate on the last couple of years I’m assuming the industry average.

All the other inputs were taken from the financial statement or from analyst projections.

The DCF gives us an estimated fair value of 87.98 dollars for ServiceNow.

Something that we can also do now is to play around with Monte Carlo simulations. What this will allow us to do is to simulate multiple DCF valuations with pre-defined ranges for each of the inputs. Each simulation will randomize the inputs between these pre-defined values. For this I also used analysts estimates.

As you can see from the above ServiceNow seems to be overvalued given that its current price of 107.08 dollars is above P90. From these simulations we can extrapolate that there’s more than 90% probability of ServiceNow being overvalued.

Please be free, as before, to fill in your own values. Make the valuation your own and do yourself a DCF valuation using your own assumptions: DCF – The Fair Value Journal

EPS Growth (Weight: 35%)

For this valuation method, I’ve used the current EPS and the analysts estimates of EPS growth. I also assumed a 25 PE for the company.

Then again used the Monte Carlo simulations to check what happens when the input values change within a specified range:

Using this valuation method, ServiceNow that is currently priced at 107.08 dollars seems to be undervalued being currently priced around P10. From this we can extrapolate that there’s more than ~90% probability of the stock being undervalued.

This seems to be the contrary of what we’ve seen on the DCF. Let’s check a historical valuation next.

As before, feel free to try this yourself: EPS Growth – The Fair Value Journal

Historical P/S (Weight: 20%)

The current P/S (Price / Sales) ratio is below its 10 Year average. This means that the company is undervalued by this metric. Assuming a mean reversion to its historical average of 14.97 we can assume a fair value of 153.76 dollars.

For every type of historical and relative valuation you can use the same free tool: Historical / Relative Valuation – The Fair Value Journal

✍️Summary

Now that we did all the heavy work, let’s take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I’ll probably start buying around 93.93 dollars given the uncertainty around the company and the fact that I still need to do more research on it.

As always, remember that the fair value estimate has a 100% probability of being wrong and it will never be a precise number, even if it has decimals next to it 😮

Overall it seems ServiceNow is fairly valued or at most a little undervalued at the current prices.

Fair Value: 108.81 dollars