Friends,
Last week, we shared with you a primer on how to view earnings of some SaaS stalwarts. We particularly called out ServiceNow, saying that while growth of the company's AI initiatives would be impressive (it was; Now Assist is expected to bring in $1.5 billion in annual contract value), it wouldn't be what moved the market.
We were right. Shares plunged 17% in a single day last week -- with the stock now down 64% from last year's highs.
So what should we be focused on?
The answers to these three questions, from last week:
Is it needle-moving? While the growth of AI tools is great, it may not be needle-moving.
What's the margin profile? Because AI requires computing costs, the margins are lower. Investors need to see how much lower that is.
Can it make up for losses? If these AI tools are effective, many customers will renew fewer seat subscriptions. Will the gross profit (see the margin question above) from AI tools offset losses from seats?
While ServiceNow's first quarter was -- by all measures -- solid, its guidance left too much to be desired.
Consider the following dynamics that were revealed:
- If NowAssist hits $1.5 billion in 2026, that is needle-moving, representing 9% of expected revenue for the year.
- However, the margin profile has deteriorated: gross margins have contracted 490 basis points in two years (see below). There is concern that, as NowAssist grows, that trend will continue.
But the most important figure comes if we strip out the effect of acquisitions and make some assumptions about how much NowAssist is contributing to revenue growth. By doing this, we see how much traditional (seat-based) subscription revenue is expected to grow.
We can't get precise numbers because management doesn't break them out, but it's a safe assumption that seat-based subscription revenue is likely only growing in the low-teens percentages.
That matters because before 2024, this figure had never fallen below 23% — representing a significant deceleration.
Does this mean ServiceNow stock is dead in the water?
Hardly.
Even though none of us owns it, we think ServiceNow is attractively valued. If NowAssist can continue growing and margins stabilize, the stock could be a great investment moving forward.
But the real take-home message is this:
We are in the middle of an enormous, AI-driven shift. That creates tons of moving pieces that can be hard to follow. At the end of the day, however, all that matters is the growth of profits. That means keep an eye on both revenue and margins.
No matter what happens between now and 10 years from now, if you're betting on companies that are sustainably growing revenue and margins, you'll likely be sitting on huge gains.
Wishing you investing luck in the months ahead,
|
|
Brian Feroldi, Brian Stoffel, & Brian Withers
Long-Term Mindset
PS - Join Stoffel in a webinar later today on this topic: The 5 Moats You Must Master - How AI Is Changing SaaS Moats. Click here to register.
|
​