By Morgan Stanley downgraded ServiceNow (NYSE: NOW) from “Overweight” to “Equal-Weight” on October 21, 2024 ahead of the company’s Q3 earnings report.
Despite the downgrade, Morgan Stanley raised its price target for the stock from $900 to $960, reflecting mixed signals about the company’s near-term prospects.
Shares reacted negatively, dropping 2% at the opening.
According to Morgan Stanley analyst Keith Weiss, while demand for ServiceNow’s products remains stable, the lack of clear upside in valuation, combined with high investor expectations surrounding the Pro Plus adoption, has balanced the risk/reward outlook.
Weiss highlighted concerns about the company’s leadership, particularly following the departure of former COO CJ Desai, and the potential long-term impact of leadership uncertainty on product strategy.
Q3 earnings expectations
ServiceNow is set to report its Q3 earnings on October 23, 2024, with Wall Street expecting earnings of $3.45 per share on $2.75 billion in revenue.
While analysts believe these targets are achievable, Oppenheimer’s Brian Schwartz recently noted that high expectations for subscription growth in 2025 might temper market enthusiasm.
The Q3 results are likely to confirm the company’s positive momentum, but any underperformance in subscription growth could dampen investor sentiment.
Schwartz also upped his price target to $1,020, citing solid execution but cautioning that future growth estimates may not be as optimistic as the market anticipates.
Diverging analyst views
Several analysts have revised their ratings and price targets for ServiceNow.
Deutsche Bank reiterated its Buy rating, raising its target to $1,020 after conducting partner checks that showed continued strong momentum.
BMO followed suit, increasing its price target to $1,025, driven by positive feedback from the reseller community.
UBS set a Wall Street-high price target of $1,055 after finding that two of ServiceNow’s largest partners exceeded their growth expectations, further underscoring the strength of the business.
However, Guggenheim remained more skeptical, maintaining a Sell rating with a price target of $716, citing concerns about Carahsoft, a key government reseller partner, which is under investigation by the Department of Justice.
Leadership changes and product strategy concerns
One issue weighing on investor sentiment is the recent departure of COO CJ Desai, which some analysts believe could impact ServiceNow’s product leadership and strategy.
While the company’s business momentum remains strong, the long-term effect of this leadership change has caused some analysts to adopt a cautious stance.
Morgan Stanley specifically noted that the leadership gap could be a potential risk for future growth, particularly as the company navigates the complexities of maintaining its dominance in the enterprise software space.
Fundamental performance indicators
ServiceNow has consistently outperformed in the enterprise software market, supported by its robust subscription model, which accounted for over 96% of its revenue in Q2 2024.
The company’s competitive advantage lies in its ability to offer customizable, AI-driven workflow solutions that are deeply embedded in client operations.
This has resulted in high switching costs for customers and a steady revenue stream.
Over the past few years, the company has maintained an impressive 5-year CAGR of 27% in revenue, demonstrating its resilience in a competitive market.
Additionally, its gross margin of 79% and a history of strong cash flow generation emphasize its financial strength.
Valuation metrics
At current prices, ServiceNow trades at 57x its FY25 expected earnings and 16.7x its forward EV/revenue.
These are high multiples, even for a leading cloud software firm, particularly given the slowdown in growth momentum.
The company’s stock-based compensation (SBC) remains a concern for investors, with SBC in the last 12 months accounting for over $1.6 billion, which dilutes shareholder value and distorts cash flow metrics.
Even when factoring in the company’s competitive position and AI initiatives, the premium valuation raises questions about whether ServiceNow can continue to outperform in the medium term.
Now that we’ve analyzed the business from a fundamental perspective, it’s time to turn our attention to the stock’s technicals to see where the price might be heading next.
Facing short-term resistance at $950
Although ServiceNow’s stock remains extremely strong on all long-term – monthly, weekly, daily – charts, if we narrow it down to hourly charts, one can see that it has been facing some resistance above $950 having made a double top near that level since September 23.
Source: TradingView
Hence investors and traders who yet don’t have a position in the stock but are bullish on the stock must wait for the company to report its Q3 earnings and for the stock to give a daily closing above $950 before initiating fresh long positions.
Traders who have a bearish outlook on the stock can take a short position in the stock at current levels near $910 with a stop loss at $956.
However, considering the Q3 results are just two days away, it would be better to play this short trade by purchasing ServiceNow’s $900 Put Option expiring on October 25 at $20.
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