Software-as-a-service (SaaS) stocks such as ServiceNow (NOW) and Zendesk (ZEN) have generated significant wealth for long-term investors in the last decade. These companies have a subscription-based model that allow them to generate cash flows across business cycles.

In the last five years, ServiceNow stock has returned 673% while Zendesk has soared 355%, easily surpassing the S&P 500 returns of 120% since December 2016. However past returns don’t matter much to current investors. 

Despite stellar gains, NOW and ZEN stocks are down 14% and 36% respectively from record highs allowing you to buy the dip. Between the two, let’s see which stock is currently the better buy.

The bull case for ServiceNow

ServiceNow aims to accelerate the digital transformation processes of enterprises and has increased its sales from $1.93 billion in 2017 to $4.5 billion in 2020. Its top-line should move higher in the upcoming years as well, given market research company IDC expects digital transformation-related enterprise spending to touch $7.8 trillion by 2024. 

Comparatively, ServiceNow’s management expects its total addressable market to widen to $175 billion in 2024 from $114 billion in 2020. It also estimates revenue to surpass $10 billion in 2024 and $15 billion in 2026.

ServiceNow offers a wide variety of cloud-based tools that allows organizations to automate multiple workflows across internal departments. It aims to improve IT, customer, and employee-related workflows and ServiceNow’s suite of low-code development tools should lower operational costs and improve enterprise-level efficiency over time.

In Q3 of 2021, the company’s subscription sales rose by 31% year over year to $1.43 billion, on the back of robust customer renewal rates that stood at 98%. Its remaining performance obligations or RPO metric surged by 32% to $5 billion.

Valued at a market cap of $120 billion, ServiceNow sales are forecast to touch $7.37 billion in 2022, valuing the stock at an expensive forward price to sales multiple of 16.3x. Its earnings per share are forecast to rise at an annual rate of 27% in the next five years. Its forward price to earnings multiple of 83x is also steep.

The bull case for Zendesk

Valued at a market cap of $12.34 billion, Zendesk is a software development company. Its flagship product is Zendesk support which is a system for tracking and solving customer support tickets across multiple channels. It also offers Zendesk Chat which is a live chat software to connect with customers across devices.

Zendesk sales have increased from $430.4 million in 2017 to $1.02 billion in 2020. Analysts now expect sales to touch $1.33 billion in 2021 and $1.7 billion in 2022. Comparatively, its earnings per share is forecast to increase from $0.52 in 2020 to $0.89 in 2022. In the next five years, its earnings are estimated to grow at an annual rate of 30%.

In Q3 of 2021, Zendesk sales rose by 32% year over year. The company expects Q4 sales to rise by 30% to between $366 million and $372 million.

Despite the recent pullback in its share price, Zendesk is valued at a forward price to sales multiple of 7.3x and a price to earnings multiple of 114x.

The verdict

I believe Zendesk is currently the better buy.  In the last 12-months, Zendesk’s gross margin is close to 79% while this metric for ServiceNow is also similar to 77.5%. While Zendesk is valued at a lower price to sales multiple, its price to earnings ratio is significantly higher compared to ServiceNow stock.  This indicates Zendesk continues to sacrifice profitability for growth.

Right now, Zendesk’s lower size provides it with enough opportunities to grow top-line at a higher pace than ServiceNow. Its asset-light business model should also allow it to expand profit margins at a solid pace over time, making it a better stock compared to ServiceNow right now.

Zendesk is trading at a discount of 40% compared to Wall Street estimates. Comparatively, ServiceNow is down 20% from consensus price targets.

NOW shares were trading at $626.38 per share on Tuesday afternoon, up $21.01 (+3.47%). Year-to-date, NOW has gained 13.80%, versus a 24.72% rise in the benchmark S&P 500 index during the same period.

About the Author: Aditya Raghunath

Aditya Raghunath is a financial journalist who writes about business, public equities, and personal finance. His work has been published on several digital platforms in the U.S. and Canada, including The Motley Fool, Finscreener, and Market Realist. More...

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