The past six months have been a windfall for Elastic’s shareholders. The company’s stock price has jumped 90.6%, hitting $90.56 per share. This performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Elastic, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Why Is Elastic Not Exciting?
We’re happy investors have made money, but we don’t have much confidence in Elastic. Here are three reasons you should be careful with ESTC, plus one 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 $338.9 million in Q2, and over the last four quarters, its year-on-year growth averaged 14%. This performance slightly lagged the sector and suggests that increasing competition is causing challenges in acquiring/retaining customers. 
2. Relatively Long Payback Periods Delay Returns
The customer acquisition cost (CAC) payback period represents the months required to recover the cost of acquiring a new customer. Essentially, it’s the break-even point for sales and marketing investments. A shorter CAC payback period is ideal, as it implies better returns on investment and business scalability.
It’s relatively expensive for Elastic to acquire new customers as its CAC payback period checked in at 253 months this quarter. The company’s slow recovery of its sales and marketing expenses indicates it operates in a highly competitive market and must invest to stand out, even if the return on that investment is low.
3. Operating Margin in Limbo
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.
Looking at the trend in its profitability, Elastic’s operating margin might have fluctuated slightly but has generally stayed the same 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 negative 2.6%.
Final Judgment
Elastic isn’t a terrible business, but it doesn’t pass our bar. After the recent rally, the stock trades at 4.8× forward price-to-sales (or $90.56 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. Let us point you toward a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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