Promising software companies tend to trade at fairly high valuation multiples. The lure for investors is the scalability of the business. It can be costly to develop, test and market new software products, but once a critical mass of sales is reached, gross margins skyrocket - because the marginal cost of each deliverable is fairly small.
Once a software company swings solidly into profitability, the shares often get a boost as investors anticipate a steep increase in revenues and earnings as the stock “grows into” its previously lofty valuation.
Alteryx Inc. (AYX - Free Report) appears to be on the brink of just such an inflection point and a Wednesday selloff may be just the catalyst investors needed to achieve an attractive entry point.
Based in Irvine, CA in the heart of Silicon Valley, Alteryx is a fast-growing developer of data science and analytic software. Their products put the power of advanced data science in the hands of the end user.
The genesis of Alteryx was a data engine that incorporated data from the US Census and allowed customers to analyze the information graphically in order to reach target demographics as accurately as possible. Eventually, Alteryx software was included by the Census Bureau in packages of information it sold commercially.
That original product grew into analytics tools that allow customers to easily manage and evaluate sets of data of all sizes, from small and specific to huge sets of global information. The goal is to make advanced data science functionality available to solve complex business problems even to those who don’t have rigorous training in the field.
Business is booming.
After operating at near break even levels for several quarters, Alteryx broke through in Q3 2019 with a net profit of $0.24/share, handily beating the Zacks Consensus Estimate of just $0.08/share.
Analysts are expecting another profitable quarter with $0.29/share in net earnings on $131 million in revenues when the company posts year end results on February 13th, bringing full year 2019 earnings to $0.60/share – a massive improvement over the $0.02/share loss Alteryx posted in 2018.
Projections for 2020 are even better with $516M in sales and $0.83/share in net earnings – increases of 31% and 39%, respectively.
That’s really the sweet spot for a software company – the point at which earnings start to grow faster than revenues because of the effect of improving margins.
Due in part to a strong rally over the past two months, Alteryx still trades at a very rich 12-month forward P/E ratio of 175X, but investors caught a break when the shares fell more than 6% on Wednesday on no significant news for the company or the industry.
Another earnings beat next week should get Alteryx moving in a positive direction again, making this temporary selloff a buying opportunity.
Just as we often say that cheap stocks are cheap for a reason, it’s likewise true that expensive stocks can be expensive for a reason. In the case of Alteryx, the high multiple is a reflection of the company’s enormous potential.
You wouldn’t want a whole portfolio full of high-priced names, but having a few companies with this type of growth potential can represent a great opportunity to hit some home runs.
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