Over the past six months, PagerDuty’s stock price fell to $18.40. Shareholders have lost 11.8% of their capital, which is disappointing considering the S&P 500 has climbed by 7.7%. This may have investors wondering how to approach the situation.
Is there a buying opportunity in PagerDuty, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Despite the more favorable entry price, we don't have much confidence in PagerDuty. Here are three reasons why there are better opportunities than PD and a stock we'd rather own.
Why Is PagerDuty Not Exciting?
Started by three former Amazon engineers, PagerDuty (NYSE:PD) is a software-as-a-service platform that helps companies respond to IT incidents fast and make sure that any downtime is minimized.
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.
PagerDuty’s billings came in at $117.8 million in Q3, and over the last four quarters, its year-on-year growth averaged 9.2%. This performance slightly lagged the sector and suggests that increasing competition is causing challenges in acquiring/retaining customers. 
2. 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 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.
PagerDuty’s expensive cost structure has contributed to an average operating margin of negative 17.8% 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 PagerDuty reeled back its investments. Wall Street seems to be optimistic about its growth, but we have some doubts.
3. Cash Flow Margin Set to Decline
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.
Over the next year, analysts predict PagerDuty’s cash conversion will fall. Their consensus estimates imply its free cash flow margin of 21.8% for the last 12 months will decrease to 17%.
Final Judgment
PagerDuty isn’t a terrible business, but it doesn’t pass our bar. Following the recent decline, the stock trades at 3.3× forward price-to-sales (or $18.40 per share). This valuation multiple is fair, but we don’t have much faith in the company. We're fairly confident there are better stocks to buy right now. We’d recommend looking at The Trade Desk, the nucleus of digital advertising.
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