2 High-Growth Software Stocks to Consider

Investors are always on the lookout for growth stocks that can generate massive returns as they outperform broader markets. Here are two stocks in the software segment that have generated market-beating returns since their IPOs and can move higher given the expansion of their total addressable markets.

Zendesk: Up more than 400%

Shares of Zendesk (NYSE:ZEN) have gained roughly 500% since the company went public in May 2014, easily outperforming tech ETFs and broader indexes in this period.

Zendesk provides businesses with tools to understand and manage customer relationships. All its products share a common interface; they are developed to support a shared services infrastructure and a common customer-data platform.

In the third quarter (reported in late October), Zendesk revenue increased by 36% year over year to $210.5 million. This growth was primarily driven by the expansion of its customer base, which now stands at 150,000. The company’s dollar-based net expansion rate — which measures revenue from existing customers — was 116%. Zendesk expects this metric to be between 110% and 120% in the next year.

Zendesk is optimistic about growing sales to $1 billion in 2020 and eventually becoming a multibillion-dollar entity in terms of revenue.

It now has customers in 160 countries and saw revenue growth across all size customers in the third quarter. That growth has been attributed to the company’s omnichannel solutions, including The Zendesk Suite, which has north of 5,000 customers and gives customers access to multiple products through a single subscription.

The company is optimistic about its ability to lead innovation in the customer relationship management (CRM) space and continues to focus on product and platform development. For example, it recently launched Sunshine Conversations, which enables enterprises to deliver what it believes to be the future of “conversational business,” a term that refers to companies communicating with customers.

Zendesk Sunshine is an “open and flexible CRM platform,” according to the company. It allows users to collate and understand vast amounts of customer data. Zendesk is optimistic about expanding the customer base with Sunshine as several enterprises continue to use legacy CRM platforms for analysis.

Zendesk Gather was launched in October 2019 to provide customer support via online community forums. Using this tool, customers can engage with each other as well as connect with company experts to leverage insights rather than banking on a single customer service agent.

ServiceNow: Up 1,000%

Shares of ServiceNow (NYSE:NOW) have gained a staggering 1,100% since its IPO back in June 2012. ServiceNow is also an enterprise-facing company that helps businesses automate certain operations and processes.

Its solutions are integrated across functions such as customer support, human resources, and security operations. ServiceNow has expanded its suite of services to include several segments over the years.

In the third quarter, ServiceNow’s subscription sales were up 33% to $835 million. The company grew its number of customers with an annualized contract value over $1 million to 809, up 32% year over year. 

In Q3, ServiceNow closed 46 deals with an annualized contract value of over $1 million, a growth of 84% versus the prior-year period. One of the key drivers of its revenue (other than the expansion of the customer base) is a retention rate of an astonishing 99%. ServiceNow attributes this rate to its focus on customer service as well as high switching costs for enterprises.

The shift to digital continues to drive strong demand for ServiceNow products, especially for its IT portfolio. During the company’s earnings call, outgoing CEO John Donahue said:

Simply, what’s happening is customers who are pursuing digital transformation are investing in ServiceNow’s full suite of IT products. They see the value of … leveraging our entire product suite and unique platform. This is a clear trend.

According to an IDC report, global enterprises will spend a massive $7.4 trillion on digital transformation over the next four years, providing opportunity for ServiceNow and peers to grow their top lines at a solid pace.

Stock metrics

Zendesk and ServiceNow are expected to continue to grow sales at a fast clip, according to analysts, who expect ServiceNow sales to reach $5.55 billion in 2021, up from $2.61 billion in 2018. Zendesk sales are expected to rise from $599 million to $1.34 billion in the same period. 

ServiceNow is valued at $56.4 billion in market cap, or 15.5 times forward sales estimates. The stock’s forward P/E stands at 71, with an estimated 5-year PEG ratio of 3.06.

Zendesk has a market cap of $9.2 billion, or 11 times forward sales. Its forward P/E stands at 143, while the 5-year estimated PEG ratio is 4.66. 

The high valuation metrics for both these stocks might be cause for concern, especially if a recession hits the markets in 2020 and enterprise tech spending slows down, but a drop in price would make the stocks more attractive.  

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