It is fun to look at the new, exciting companies that have gone public within the past year. However, there is typically a lot of hype around them. The long list of companies that have been on the market for over a year, however, is a great place to search for additions to your portfolio, because investors like you and me can understand their businesses better now that they have had more time as a public company.
PagerDuty (PD 3.21%) could fit the bill. Founded in 2009, it didn't go public until late 2019. The company is working on solving important problems to make it easier for companies to move to the cloud. Is the stock good enough to add to your portfolio?
Image source: Getty Images
A land-and-expand approach to problem-solving
PagerDuty is a software provider that ensures businesses' online platforms are running smoothly and reliably, to ensure good customer relations. When seconds matter, PagerDuty aims to reduce website downtime for its business clients.
Among its products, PagerDuty's on-call management tool makes it easy for employees to report issues, and it monitors online operations 24/7. Its incident response tool aims to reduce downtime to as little as possible, and its other tools provide quick detection and readiness for any issues.
As such, PagerDuty has seen increased adoption by businesses.
| Q3 2021 | Q2 2022 | Q3 2022 | |
|---|---|---|---|
| Customers spending over $100,000 | 401 | 501 | 543 |
| Customer growth (YOY) | 10.4% | 6.2% | 5.5% |
Source: PagerDuty. YOY = year-over-year
The company lands customers with a free trial (nearly 4,500 users currently take part) and its core products allow it to expand its relationships with them, leading to impressive revenue growth. In the third quarter, sales grew 33% to $71.8 million. PagerDuty has kept its churn rate below 5%, which shows how well-liked the company's products are by its customers.
The company's primary competitive advantages are its sticky product and the ability to land and expand with customers. PagerDuty offers a mission-crucial service that would be hard for a company to switch away from because of high contract values -- some of which are over $100,000 -- and the learning curve for its customers to adopt a new product.
What makes PagerDuty risky?
As appealing as its competitive advantages are, there are plenty of risks with this company. The most concerning thing is that its growth has been rapidly slowing.
| FY 2019 | FY 2020 | FY 2021 | Q3 2022 | |
|---|---|---|---|---|
| Revenue growth (YOY) | 48% | 41% | 28% | 34% |
| Customer growth (YOY) | 14.5% | 13.9% | 4.8% | 5.5% |
| Net retention rate | 140% | 122% | 121% | 124% |
Source: PagerDuty SEC Filings. FY=Fiscal Year. YOY = year-over-year
Since 2018 (the fiscal year 2019) -- right before PagerDuty came public -- the company's customer and revenue growth have declined. While it is still a good sign to see its customer count increase marginally year over year, it is a meaningful slowdown compared to 2018.
The second risk that I see with PagerDuty is its lack of profitability. Since the fiscal year 2020, the company's net loss as a percentage of revenue has continuously worsened.
| FY 2020 | FY 2021 | Q3 2022 | |
|---|---|---|---|
| Net loss as a percentage of revenue | 30% | 32% | 36% |
Source: PagerDuty SEC Filings. FY=Fiscal Year.
Slowing customer growth is indicative that the company's overall growth will start to stagnate, meaning that the company's sales and marketing expenses are becoming less effective. It is still spending over 55% of revenue on sales and marketing for just 5% customer growth, so it is evident that PagerDuty may not be spending wisely.
I am typically OK with a fast-growing company that has large net losses, but when that company begins to see less growth, its path to profitability is much more important, and slowing growth combined with increasing losses is concerning.
Is it a buy?
While PagerDuty's products are crucial for businesses, I don't think the stock is a great buy today. It helps solve critical problems for its customers, but PagerDuty isn't attracting them at the pace it was a few years ago. The company has shown that it is able to grow relationships with the customers it does have, but that alone is not enough to make it investable.
The slowing growth and the losses concern me. And while trading at 12 times sales, it's trading at a pretty pricey level compared to competitors. Dynatrace (DT 0.53%) -- a PagerDuty competitor -- trades at a slightly higher sales ratio of 21, but the company is profitable. I tend to pay more attention and be more critical of a company's valuation when I see slowing growth, and PagerDuty's sets off an alarm in my head.
While I like PagerDuty's business model, the financial picture tells me a different story. Its products are vital to a business' digital operations, but the financials show me that they haven't been popular enough to sustain continued growth. For this reason, I am staying away from PagerDuty for now. If the company can turn around its growth prospects and reduce its net loss, I would be very interested. For now, however, I will continue to watch this software-as-a-service stock from afar.
