This ‘pandemic-winning’ stock still isn’t cheap, according to these fundamentals

This article was written exclusively for Investing.com

The so-called “winners of the pandemic” have taken a beating over the past year, even relative to the decline in broader market indices. DocuSign (NASDAQ:) has been no exception.

In September, the electronic signature software provider was trading for more than $300. On Friday it closed just above $60. Among the more than 700 large-cap stocks (more than $10 billion in market cap), only eight have fallen further from their 52-week high.

At the very least, this kind of drop makes the e-signature solutions provider’s stock interesting. Even accounting for the danger of “anchoring bias” – which we’ve discussed in the context of other fallen angels like Coinbase (NASDAQ:) – an 81% drop suggests that stocks could at least be cheap. So does the unbelievable erasure of nearly $50 billion of stock value in less than ten months.

But intriguing is not the same as convincing. Looking at DOCU with fresh eyes, defending a long position isn’t all that appealing, at least not yet. There are very real concerns and very real challenges here. The size of the sale up to this point is not relevant to those risks and certainly does not offset them.

DOCU shares are not cheap

A big problem with buying the dip (or the crash, if you will) is that, even down 81%, DocuSign still isn’t cheap from a fundamental perspective.

At first glance, it’s true that the San Francisco, US-based software provider seems to offer value. For fiscal year 2023 (which ends in January), DocuSign forecasts revenue of just under $2.5 billion. With an enterprise value of $12 billion, DocuSign’s price-to-revenue multiple is less than 5x, which seems attractive in a software space where many companies received double-digit multiples, and some still do.

Based on their adjusted numbers, DocuSign is very profitable. Trailing 12-month adjusted EPS is $1.92, suggesting a P/E multiple of just 32 times. Free cash flow for the last 12 months – without adjustments – is just under $500 million, which means DOCU is trading at 24 times free cash flow. It is a multiple that implies little growth in the future.

But both metrics have significant problems. Five times the income just “seems” cheap because, in a bull market, investors would pay 15 or 20 times. Those days are long gone, probably for quite some time.

Other than that, investors need to value a stock based on earnings and cash flow. In DocuSign’s case, neither is as impressive as it sounds, for one key reason: stock-based compensation.

Like many tech companies, DocuSign pays its employees with a good amount of stock. And like almost all tech companies, DocuSign excludes that stock issue from its adjusted earnings figures.

But stock-based compensation is a real expense. And for DocuSign, it’s a significant expense. Over the past four quarters, DocuSign has posted $437 million in stock-based compensation. Its adjusted operating income for the same period is $428 million.

If an investor considers issuing shares – an issue that dilutes existing shareholders – DocuSign has been an unprofitable business for the past year. The $500 million of free cash flow also almost disappears when you factor in the issuance of shares (which, as a non-cash expense, is not reflected in the cash flow calculations).

In this context, an enterprise value of $12 billion doesn’t seem cheap at all.

Concerns for the future

To be fair, investors should look not only at the fundamentals, but also at the future. High-growth stocks don’t need to generate significant earnings, if any, right now to be an attractive investment going forward.

DocuSign’s problem is that it’s not going to be a high-growth company anytime soon. First-quarter revenue was up 25% year over year, on top of 58% growth a year earlier. But the company’s full-year forecasts, including in terms of sales, suggest just 18% growth for the full fiscal year 2023 and just 16% in the remaining three quarters.

The news is more worrying in terms of billing. Billing takes into account the number of new businesses brought on board by adjusting for deferred revenue and other factors. (For a subscription business, a good portion of a period’s revenue comes from recognizing sales that occurred in the past.) DocuSign’s full-year guidelines forecast revenue growth of only 7% to 8%, and an increase of approximately 5% for the last three quarters of FY23.

The sharp drop in DOCU shares has come as the underlying growth of the business has slowed sharply. That is why the results reports have been a problem for the action. DOCU fell 42% after the third quarter report in December, 20% after the fourth quarter release in March and 32% (in two sessions) after the first quarter figures for this month.

Each quarter has shown another leg down in the company’s growth. So while general market weakness has contributed to the drop in DOCU’s shares since September, much of the selling has come in response to the company’s actual results.

The sharp drop in DOCU shares has come as the underlying growth of the business has slowed sharply. That is why the results reports have been a problem for the action. DOCU fell 42% after the third quarter report in December, 20% after the fourth quarter release in March and 32% (in two sessions) after the first quarter figures for this month.

Each quarter has shown another leg down in the company’s growth. So while general market weakness has contributed to the drop in DOCU’s shares since September, much of the selling has come in response to the company’s actual results.

Given the combination of minimal “real” returns and a sharp slowdown in growth, it’s no wonder the stock has sold off. Nor does that sale necessarily create a buying opportunity.

In defense of buying DocuSign stock

To be fair, not all hope is lost. Revenue and billing forecasts are certainly disappointing. But DocuSign is comparing with an impressive fiscal year 22, and there is still a long-term opportunity. DocuSign’s Agreement Cloud expands beyond electronic signatures into “contract lifecycle management,” underpinning an estimated $50 billion annual revenue opportunity.

Meanwhile, even DocuSign’s own CEO has admitted, on more than one occasion, that the company has lost sight of the proverbial ball. The company failed to execute on its “land and expand” strategy, in which it attracts customers and then systematically sells more and more services.

There is a lot of room for improvement on that front as DocuSign adjusts to a new normal. And like many tech companies, that new normal may include lower compensation (stock-based and otherwise) which in turn helps margins.

Certainly, DocuSign can’t be written off just yet. But that’s not enough for the stock to be a buy. Difficult quarters ahead. We don’t really know how DocuSign will perform in a recession – the company only went public in 2018 – but trends like a slowing housing market will presumably be a headwind if the macro environment deteriorates. And, to say the least, it’s nerve-wracking to own a pre-earnings stock (next report coming in September) when that stock has averaged a drop of more than 25% after its last three releases.

In short, the company has a lot of work to do and some pitfalls to avoid. At a proper assessment, it may be worth taking that risk. The problem is that even though it’s down 81%, DOCU stock still hasn’t reached the right valuation.

Disclaimer: At the time of this writing, Vince Martin has no positions in any of the listed stocks.

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