DocuSign (NASDAQ:DOCU) stock has been on fire in 2020 amid surging demand for digital contract management solutions, with DocuSign up more than 160% year-to-date.
Wall Street’s love affair with this work from home favorite, however, is overdone.
DocuSign is a great company. But DOCU stock is significantly overvalued at current levels, with the premium valuation being chalked up to Wall Street hype on the back of surging demand for DocuSign’s e-doc solutions.
That demand will taper off over the next few quarters, as remote tailwinds ease. As that happens, the hype surrounding DocuSign will fade, valuation headwinds will rear their ugly head and DOCU stock will fall.
Needless to say, DOCU stock is a “buyer beware” situation at these levels.
Here’s a deeper look.
Fading Momentum
There’s no denying the fact that DocuSign’s demand trends have been exceptionally strong so far in 2020.
As offices across the globe have closed over the past several months, enterprise demand for DocuSign’s digital contract management solutions – which enable companies to digitally create, edit and sign documents, among various other mission-critical processes – has soared. In the first quarter of fiscal 2021, DocuSign reported 30% customer growth, 40% revenue growth and 60% billings growth.
These strong demand trends have paved the way for DOCU stock to rally 160% in 2020 to all-time highs.
But such strong demand trends will likely weaken over the next few quarters for a few reasons.
First, demand here is front-loaded. That is, because the global economy essentially shut down over night, demand for remote work solutions like DocuSign’s offerings soared overnight.
It’s now been five months since offices globally have closed. Most enterprises have likely already adapted to this “new normal.” Thus, second- and third-quarter customer growth numbers will likely be significantly lower than what was reported in Q1.
Second, the global economy is slowly normalizing. In places where the virus is under control, like New York City, employees are returning to the office, albeit slowly. This gradual flow of employees back into the physical workplace will somewhat undermine the company’s strong remote work tailwinds that were unobstructed for several months.
Third, customer growth going forward will likely be powered by smaller customers. After all, the company has already signed up 18 of the world’s 20 biggest pharma companies, 10 of the world’s 15 biggest financial services companies and seven of the world’s 10 biggest technology companies.
Customer growth going forward will be powered more by smaller businesses, who will sign up for smaller contracts, implying a headwind for overall revenue growth.
As such, over the next six to 12 months, I see DocuSign’s growth narrative meaningfully decelerating from where it was in the first quarter.
Worrisome Valuation Headwinds
Meaningful deceleration wouldn’t be a problem for DOCU stock if the stock were more reasonably valued. After all, the company still has tremendous long-term growth prospects as a provider of increasingly important digital contract management solutions to the enterprise.
But it’s not reasonably valued.
DOCU stock is trading at a price-sales multiple of 35, at a cash flow multiple of 290 and a forward price-earnings multiple of 450. By comparison, the market is trading at a trailing price-sales ratio of 2, a cash flow multiple of 13 and a forward P/E of 22.
Clearly, DOCU stock is trading at very stretched multiples, which imply that shares are priced for absolute perfection going forward.
Meaningful deceleration is not absolute perfection. Consequently, the convergence of slowing growth on a rich valuation could cause significant pain in DOCU stock over the next six to 12 months.
Bottom Line on DOCU Stock
Long term, I like DocuSign. Gone are the days of paper documents. Here are the days of digital documents. In that era, DocuSign’s digital contract management solutions are not just important, but mission critical.
The company will grow its customer base, revenues and profits by leaps and bounds over the next five to 10 years. Over that stretch, DOCU stock will head higher.
But, in the near term, this stock is out over its skis. And slowing growth over the next few quarters on the back of easing remote work tailwinds could cause significant pain in the stock.
Such pain could ultimately turn into a buying opportunity. But, until then, it’s best to wait on the sidelines with this red-hot growth stock.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not own a position in any of the aforementioned securities.