Q2 Holdings’s stock price has taken a beating over the past six months, shedding 38.5% of its value and falling to $47.20 per share. This may have investors wondering how to approach the situation.
Is now the time to buy Q2 Holdings, 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 Q2 Holdings Not Exciting?
Even though the stock has become cheaper, we're swiping left on Q2 Holdings for now. Here are three reasons why QTWO doesn't excite us and a stock we'd rather own.
1. Weak ARR Points to Soft Demand
While reported revenue for a software company can include low-margin items like implementation fees, annual recurring revenue (ARR) is a sum of the next 12 months of contracted revenue purely from software subscriptions, or the high-margin, predictable revenue streams that make SaaS businesses so valuable.
Q2 Holdings’s ARR came in at $921 million in Q4, and over the last four quarters, its year-on-year growth averaged 11.2%. This performance was underwhelming and suggests that increasing competition is causing challenges in securing longer-term commitments. 
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 Q2 Holdings’s revenue to rise by 10.3%, a slight deceleration versus its 14.3% annualized growth for the past five years. This projection doesn't excite us and indicates its products and services will face some demand challenges.
3. Low Gross Margin Reveals Weak Structural Profitability
For software companies like Q2 Holdings, gross profit tells us how much money remains after paying for the base cost of products and services (typically servers, licenses, and certain personnel). These costs are usually low as a percentage of revenue, explaining why software is more lucrative than other sectors.
Q2 Holdings’s gross margin is substantially worse than most software businesses, signaling it has relatively high infrastructure costs compared to asset-lite businesses like ServiceNow. As you can see below, it averaged a 54.1% gross margin over the last year. That means Q2 Holdings paid its providers a lot of money ($45.94 for every $100 in revenue) to run its business.
The market not only cares about gross margin levels but also how they change over time because expansion creates firepower for profitability and free cash generation. Q2 Holdings has seen gross margins improve by 5.6 percentage points over the last 2 year, which is elite in the software space.
Final Judgment
Q2 Holdings isn’t a terrible business, but it doesn’t pass our bar. After the recent drawdown, the stock trades at 3.7× forward price-to-sales (or $47.20 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 Amazon and PayPal of Latin America.
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