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Over the past six months, Sprout Social’s shares (currently trading at $33.10) have posted a disappointing 15.3% loss, well below the S&P 500’s 10.2% gain. This might have investors contemplating their next move.
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Even though the stock has become cheaper, we don't have much confidence in Sprout Social. Here are two reasons why SPT doesn't excite us and a stock we'd rather own.
Why Is Sprout Social Not Exciting?
Founded by Justyn Howard and Aaron Rankin in 2010, Sprout Social (NASDAQ:SPT) provides a software as a service platform that companies can use to schedule and respond to posts on major social media networks like Twitter, Facebook, Instagram, Youtube and LinkedIn.
1. 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.
Sprout Social’s expensive cost structure has contributed to an average operating margin of negative 16.5% over the last year. Unprofitable, high-growth software companies require extra attention because they spend heaps of money to capture market share. As seen in its fast historical revenue growth, this strategy seems to have worked so far, but it’s unclear what would happen if Sprout Social reeled back its investments. Wall Street seems to be optimistic about its growth, but we have some doubts.
2. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
Sprout Social has shown weak cash profitability over the last year, giving the company limited opportunities to return capital to shareholders. Its free cash flow margin averaged 4.3%, subpar for a software business.
Final Judgment
Sprout Social’s business quality ultimately falls short of our standards. Following the recent decline, the stock trades at 4.2× forward price-to-sales (or $33.10 per share). This valuation multiple is fair, but we don’t have much faith in the company. We're pretty confident there are more exciting stocks to buy at the moment. Let us point you toward the most dominant software business in the world.