Rapid7’s stock price has taken a beating over the past six months, shedding 40% of its value and falling to $13.67 per share. This may have investors wondering how to approach the situation.
Is there a buying opportunity in Rapid7, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Do We Think Rapid7 Will Underperform?
Despite the more favorable entry price, we're swiping left on Rapid7 for now. Here are three reasons we avoid RPD and a stock we'd rather own.
1. Weak Billings Point to Soft Demand
Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.
Rapid7’s billings came in at $193.4 million in Q3, and over the last four quarters, its year-on-year growth averaged 3%. This performance was underwhelming and suggests that increasing competition is causing challenges in acquiring/retaining customers. 
2. Projected Revenue Growth Shows Limited Upside
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.
Over the next 12 months, sell-side analysts expect Rapid7’s revenue to stall, a deceleration versus its 17.1% annualized growth for the past five years. This projection is underwhelming and indicates its products and services will see some demand headwinds.
3. Shrinking Operating Margin
While many software businesses point investors to their adjusted profits, which exclude stock-based compensation (SBC), we prefer GAAP operating margin because SBC is a legitimate expense used to attract and retain talent. This is one of the best measures of profitability because it shows how much money a company takes home after developing, marketing, and selling its products.
Looking at the trend in its profitability, Rapid7’s operating margin decreased by 2.6 percentage points over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its operating margin for the trailing 12 months was 1.9%.
Final Judgment
Rapid7 falls short of our quality standards. After the recent drawdown, the stock trades at 1.1× forward price-to-sales (or $13.67 per share). This valuation is reasonable, but the company’s shaky fundamentals present too much downside risk. There are superior stocks to buy right now. Let us point you toward a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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