Big data parsing company Splunk (NASDAQ: SPLK) recently reported third-quarter results for its 2019 fiscal year, besting its own guidance from a few months prior and exceeding numbers anticipated by Wall Street analysts. Splunk is benefiting from multiple tailwinds -- including the migration to cloud computing, business needs for more data-driven insight into operations, and increasingly complex cybersecurity countermeasures -- resulting in quarter after quarter of expectation-topping performance. Though the company isn't in the black yet, the stock is worthy of consideration for investors looking for a multidecade portfolio holding.
2018 so far
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Shares of Splunk are up 28% this year as of this writing, although they're still down 19% from the all-time high reached over the summer. Though it has been a bumpy ride, the stock's performance underscores how well the business has been performing.
Splunk has its foot on the gas to grow the top line as fast as possible. (It is pushing for over $2 billion in sales next year.) That shows up in steep sales and marketing, and research and development expenses -- which have increased 30% and 43%, respectively, year-to-date. That is the primary reason Splunk operates at a loss in spite of its size.
Nevertheless, the decision to sacrifice profit now for more of it later is yielding impressive growth. Management thinks sales will rise to about $560 million for the current quarter. It also raised its full-year revenue guidance to $1.74 billion from $1.685 billion. That puts the company on track to meet its ambitious $2 billion goal next year.
Big data in the cloud
It's been a landmark couple of years for Splunk. As organizations have realized the benefits of converting big data into useful insights, Splunk has been a primary beneficiary. As the company has grown, it has reached a size where it can throw its weight around in the technology space. Since 2017, it has reported six acquisitions, ranging from the most recent buyout of Internet of Things data platform Krypton to machine-learning and cloud-computing company SignalSense late in 2017.
The biggest acquisitions, though, were Phantom (for $350 million) and VictorOps ($120 million) to boost the company's presence in the burgeoning yet fast-evolving cybersecurity business. The result has been new software offerings helping companies orchestrate the detection and prevention of security breaches, a key area contributing to Splunk's recent success and acceleration in sales growth.
Still, some investors may shy away from the stock because of the steep losses, especially as operating losses have increased this year even as revenue continues to rise. However, I think management is doing the right thing here. Gross profit margin on services is an enviable 78.8% so far this year, so adding as much of that good stuff as possible will pay off down the road.
Plus, when adjusting for one-time items and stock-based compensation, Splunk's operating profit margin is positive and rising. Adjusted operating margin was 13.6% in the third quarter and is expected to increase to 25% to 26% in the final quarter of the current fiscal year. Full-year adjusted operating margin should be 11.5% to 12%. That is driving steady growth in free cash flow -- or the money left over after basic operating expenses and capital expenditures are paid for.
That doesn't mean Splunk is an inexpensive purchase. The stock currently trades for 52 times free cash flow. Paying for half a century's worth of profit isn't usually advisable. However, bear in mind that the figure includes the cost of the company's recent acquisitions and other expansion efforts.
Nevertheless, reasons for buying Splunk stock have little to do with valuation. Rather, it's all about long-term potential: not just the size of the future payoff, but also in the company's ability to lead the charge in the big data industry. With revenue on track to grow nearly 40% this year -- an impressive feat given the company's size -- it seems the business community thinks Splunk is indeed a leader in providing usable big data insights. With plenty of runway ahead of it, this stock looks to be worth holding onto for the long haul.
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