Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Crazy Stocks

ServiceNow Proves Cloud Stocks are a Bubble

I think ServiceNow’s stock price shows cloud stocks are in a bubble. Mr. Market paid $583.51 for ServiceNow (NYSE: NOW) on 2 February 2021.

However, ServiceNow reported total assets of $8.715 billion, quarterly revenues of $1.25 billion, and a quarterly operating income of $17.93 million on 31 December 2020. Thus, I think many people who are not reading the financial numbers are buying ServiceNow stock.

Instead, I think investors are basing their purchases on the verbiage on ServiceNow’s website. ServiceNow (NOW) arrogantly calls itself the “platform of platforms” and “the foundation for all workflows.”

Some of those investors are backing their opinions with money. Over the past year, ServiceNow’s share price grew from $343.20 on 3 February 2020.

The Platform of Platforms

To elaborate, ServiceNow’s platform connects employees with each other and the organization in the cloud. Hence, ServiceNow offers an excellent solution for all the people working remotely because of coronavirus.

In particular, ServiceNow claims 6,900 enterprise customers use its platform of platforms. Those enterprise customers include 7Eleven, Deloitte, Ricoh, the NBA, the Intercontinental Exchange, Scotland’s National Health Service (NHS), and the City of Copenhagen.

Services the platform of platforms can provide include an App Engine that builds custom apps. Ultimately, ServiceNow claims the platform of platform can replace an organization’s traditional IT infrastructure with a cloud-based structure.

Does ServiceNow Make Money?

Service Now Inc. (NOW) makes some money. It reported a quarterly gross profit of $971.23 million on 31 December 2020.

In 2020, the quarterly gross profit grew from $740.32 million on 31 December 2019. However, the quarterly operating income fell from $28.51 million on 31 December 2019 to $17.93 million on 31 December 2020.

In contrast, ServiceNow’s quarterly operating cash flow rose from $421.21 million on 31 December 2019 to $686.52 million on 31 December 2020. In addition, the quarterly ending cash flow rose from $152.45 million to $327.62 million in the same period.

Plus, ServiceNow can generate enormous amounts of cash occasionally. It reported a quarterly ending cash flow of $812.85 million on 31 March 2020.

However, ServiceNow sometimes borrows enormous amounts of money. It reported a quarterly financing cash flow of $963.38 million on 30 September 2020 that fell to -$203.49 million on 31 December 2020.

ServiceNow is in Excellent shape

I think ServiceNow (NOW) finished 2020 in excellent shape because it reported $1.64 billion in long-term debt and $3.092 billion in cash and short-term investments. So it has more cash than debt.

Moreover, ServiceNow is growing. For instance, quarterly revenues grew from $951.77 million on 31 December 2019 to $1.250 billion on 31 December 2020. Notably, Stockrow credits ServiceNow with six straight quarters of double digit revenue growth. For instance, ServiceNow’s revenues grew by 31.37% in the quarter ending on 31 December 2020.

Thus I think ServiceNow has an excellent business. Unfortunately, Mr. Market grossly overprices that business. In particular, Mr. Market paid $338.23 for Now on 31 January 2020 and $543.15 on 29 January 2021. Thus, Now’s share price grew by over $100 in a year.

What Service Now can Teach us About Bubbles

I believe this growth shows ServiceNow (NOW) is bubbling. Additionally, I believe ServiceNow offers some important lessons about bubbles all investors need to learn.

The first lesson ServiceNow teaches is that healthy moneymaking companies with good value characteristics can bubble. Thus, Bubbles do not just affect horrible companies such as

Second, brilliant companies with bright futures can bubble. For example, Amazon (AMZN) was one of the poster children of the turn-of-the-21st Century tech bubble.

How Bubbles Work

Third, the assumptions that drive bubbles can be true. However, unrealistic expectations also drive bubbles.

For example, Internet Bubble era assumptions about Amazon’s potential were correct. However, the Tech Bubble investors’ time-table for Amazon was wildly optimistic.

The Tech Bubble investors thought most consumers would switch to e-commerce in 2005 or earlier. Instead, the prediction was off by 15 to 20 years. Ordinary Americans did not discover Amazon until around 2015, 20 years after the Tech Bubble.

This brings us to a fourth observation about bubbles. Progress moves at a far slower speed than most people assume. For instance, it usually takes 20 to 30 years for ordinary people to adopt a new technology, however, most early investors assume it will take a few years to adopt the technology.

Consequently, excellent companies with disruptive new technologies will get caught up in a bubble. I think ServiceNow (NOW) falls into that category. Under these circumstances, I advise investors to avoid ServiceNow until the cloud bubble ends.