After Earnings, Is ServiceNow Stock a Buy, a Sell, or Fairly Valued?

ServiceNow released its second-quarter earnings report on July 23. Here’s Morningstar’s take on ServiceNow’s earnings and stock.

Key Morningstar Metrics for ServiceNow

• Fair Value Estimate: $1,050.00
• Morningstar Rating: ★★★
• Economic Moat: Wide
• Morningstar Uncertainty Rating: High

What We Thought of ServiceNow’s Q2 Earnings

ServiceNow’s second-quarter revenue grew by 22% year over year in constant currency to $3.22 billion, driven by solid renewals, generative AI, and customer workflow adoption. Non-GAAP operating margin was 29.7% for the quarter. Results topped the high end of guidance on key measures.

Why it matters: Our initial read early in the reporting cycle is that software is performing well. ServiceNow is no exception, as it is benefiting from strong demand, as uncertainty seems less of a headwind than in recent quarters.

• Subscription revenue crushed the high end of guidance and grew 22.5% year over year to $3.11 billion. We see strength across workloads and geographies, with healthy large deals. Demand from US federal accounts was strong and is expected to remain so as modernization efforts continue.
• Generative artificial intelligence remains a key driver, one that should help maintain durable growth over the next five years. Management saw strength in Pro Plus solutions, with deal count up more than 50% sequentially, while deal size also increased.

The bottom line: We raise our fair value estimate for wide-moat ServiceNow to $1,050 per share from $1,010, based on results and guidance. We view the stock as slightly undervalued and believe it offers the best union of growth and profitability in software.

Coming up: Overall guidance is as impressive as results. ServiceNow raised its full-year revenue guide by $125 million at the midpoint while holding its margin outlook steady. For third quarter, guidance was better than expected for revenue and shy of what we anticipated for profitability.

• Management believes guidance incorporates some prudent conservatism around the public sector but noted strength in the US federal in the quarter.
• We are impressed by new product traction and think this could support even better revenue growth through 2026. Given margin performance thus far, we see room for margins to come in ahead of our updated model for the rest of the year.

Fair Value Estimate for ServiceNow

With its 3-star rating, we believe ServiceNow’s stock is fairly valued compared with our long-term fair value estimate of $1,050. This implies a 2025 enterprise value/sales multiple of 14 times and an adjusted P/E multiple of 61 times.

We model a five-year CAGR for revenue of 18%. We see subscription revenue as driving almost all growth. In our view, top-line growth will be driven by continued new logo wins, and rapid upsell into those clients once landed, with upsell coming from new seats, new features within a given solution, vertical specific solutions, generative AI solutions, and ultimately additional products. Customer service, HR delivery, security operations, and platform should contribute meaningfully to growth over the next five years.

Read more about ServiceNow’s fair value estimate.

Economic Moat Rating

We assign a wide economic moat to ServiceNow, derived from high customer switching costs. The company officially reports only two segments: subscriptions and services. While we view the subscription business as having a wide moat, we do not think the company’s services segment, which is a small portion of revenue, warrants a moat. We believe ServiceNow’s moat will probably allow the company to earn returns in excess of its cost of capital over the next 20 years.

Read more about ServiceNow’s economic moat.

Financial Strength

We believe ServiceNow is financially sound. Revenue is growing rapidly, while non-GAAP margins are robust and expanding. We believe continued traction in ITSM and ITOM, along with adoption of new use cases in customer service and HR service delivery, will continue to drive strong revenue growth for at least the next five years.

As of Dec. 31, 2024, ServiceNow had $5.8 billion in cash, offset by $1.5 billion in debt, resulting in a net cash position of $4.3 billion. Gross leverage sits at about 1 times trailing EBITDA, which allows for flexibility should the environment worsen.

Operating margins are increasing as ServiceNow continues to scale, with 2019 the first year of profitability on a GAAP basis. We think ServiceNow should be able to drive approximately 50-100 basis points of margin expansion annually. Free cash flow margin was 31% in 2024, providing a preview of what we think will be strengthening margins over the next decade.

ServiceNow does not pay a dividend, but it has begun repurchasing shares to help offset dilution arising from stock-based compensation. The firm also makes an occasional relatively small acquisition. We note the company made a variety of tuck-in acquisitions over the last several years for undisclosed amounts. We expect small, feature-driven acquisitions to continue, but we have not explicitly modeled any such deals. We do not expect the company to initiate a dividend in the foreseeable future.

Read more about ServiceNow’s financial strength.

Risk and Uncertainty

We assign ServiceNow an Uncertainty Rating of High. While the firm’s valuation is high relative to peers, any execution misstep or issue in its quarterly earnings updates is likely to have a magnified impact on the shares.

While ServiceNow has rapidly gained share by displacing legacy vendors in the help desk function, as the company continues to expand into areas outside of IT, it will increasingly encounter new competitors. For example, moving more into customer experience will inevitably lead to increasing direct competition with Salesforce.

ServiceNow has made a variety of relatively small acquisitions since its IPO in 2012. We recognize that as the company matures, the likelihood of more meaningful M&A increases. Thus far, the company has executed feature driven deals where the acquired company’s technology is added to the platform. It is possible that either these deals become larger or the company makes a more transformative acquisition, which we think would heighten the risk profile of the company.

Read more about ServiceNow’s risk and uncertainty.

NOW Bulls Say

• ServiceNow’s superior product has led to rapid share gains and exceptional retention in the ITSM market. Now the company is using this strength to expand into other areas of ITOM.
• The company has added additional growth drivers, including customer service and HR service delivery, which should help propel robust growth over the next five years.
• GAAP operating margin was breakeven for the first time in 2019, and we see a decadelong runway for expansion.

NOW Bears Say

• As ServiceNow expands deeper into areas outside the core IT function, it will encounter an expanding set of competitors. Some of these will be better equipped to battle.
• The company’s market opportunity is difficult to define.
• Rapid growth, especially given the company’s scale, will inevitably slow.

This article was compiled by Isela Meraz.