Over the past six months, Elastic’s shares (currently trading at $61.65) have posted a disappointing 15% loss, well below the S&P 500’s 8.6% gain. This might have investors contemplating their next move.
Is now the time to buy Elastic, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Is Elastic Not Exciting?
Despite the more favorable entry price, we don't have much confidence in Elastic. Here are three reasons we avoid ESTC 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.
Elastic’s billings came in at $399.6 million in Q3, and over the last four quarters, its year-on-year growth averaged 13.9%. This performance slightly lagged the sector and suggests that increasing competition is causing challenges in acquiring/retaining customers. 
2. Projected Revenue Growth Is Slim
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 Elastic’s revenue to rise by 13.7%, a deceleration versus its 25.8% annualized growth for the past five years. This projection is underwhelming and suggests its products and services will face some demand challenges.
3. Operating Margin Rising, Profits Up
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.
Over the last two years, Elastic’s expanding sales gave it operating leverage as its margin rose by 5.9 percentage points. Its operating margin for the trailing 12 months was negative 2.1%, and it must keep making strides to one day reach sustainable profitability.
Final Judgment
Elastic isn’t a terrible business, but it doesn’t pass our bar. After the recent drawdown, the stock trades at 3.4× forward price-to-sales (or $61.65 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We're fairly confident there are better stocks to buy right now. Let us point you toward one of Charlie Munger’s all-time favorite businesses.
Stocks We Would Buy Instead of Elastic
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