Shareholders of PagerDuty would probably like to forget the past six months even happened. The stock dropped 23.8% and now trades at $15.75. This might have investors contemplating their next move.
Is there a buying opportunity in PagerDuty, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Is PagerDuty Not Exciting?
Despite the more favorable entry price, we're cautious about PagerDuty. Here are three reasons why you should be careful with PD and a stock we'd rather own.
1. Weak Billings Point to Soft Demand
Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.
PagerDuty’s billings came in at $150.5 million in Q4, and over the last four quarters, its year-on-year growth averaged 8.1%. This performance was underwhelming and suggests that increasing competition is causing challenges in acquiring/retaining customers. 
2. Operating Losses Sound the Alarms
Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This metric shows how much revenue remains after accounting for all core expenses – everything from the cost of goods sold to sales and R&D.
PagerDuty’s expensive cost structure has contributed to an average operating margin of negative 12.8% over the last year. Unprofitable software companies require extra attention because they spend heaps of money to capture market share. As seen in its historically underwhelming revenue performance, this strategy hasn’t worked so far, and it’s unclear what would happen if PagerDuty reeled back its investments. Wall Street seems to think it will face some obstacles, and we tend to agree.
3. Cash Flow Margin Set to Decline
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Over the next year, analysts predict PagerDuty’s cash conversion will fall. Their consensus estimates imply its free cash flow margin of 23.2% for the last 12 months will decrease to 21.2%.
Final Judgment
PagerDuty isn’t a terrible business, but it doesn’t pass our quality test. After the recent drawdown, the stock trades at 2.8× forward price-to-sales (or $15.75 per share). While this valuation is reasonable, we don’t really see a big opportunity at the moment. We're pretty confident there are superior stocks to buy right now. Let us point you toward the Amazon and PayPal of Latin America.
Stocks We Would Buy Instead of PagerDuty
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