Slack (NYSE:WORK) reports earnings after the market closes on September 8. Shares of WORK stock have been sliding in the five days prior to earnings. This may suggest that analysts are expecting the company to disappoint when they report earnings. Or, it could suggest that investors are just taking some money off the table and waiting for the next leg up.
Of course, there’s also the possibility that it’s a little bit of both. The reality is that, by most measures, Slack stock is a bit overvalued, even for an emerging tech stock. With a market capitalization of $16.19 billion (as of this writing), the stock is trading at over 25 times it’s 12-month trailing sales. Even if you project the company’s 2021 fiscal year estimate of $873 million, you’re still looking at a stock that is trading at over 18 times sales (the company is not yet profitable).
But as a company that is part of the software-as-a-service (SaaS) sector, investors may be willing to overlook the company’s stretched valuation. However, it will need some clarity on some key issues when the company reports earnings.
Is the remote work trend topping out?
When Slack last reported in June, it posted record revenue of $201.65 million. That was to be expected as companies turned their focus to remote work. It’s difficult to predict what the future of remote work will look like. However, it’s likely that many employees will be working remotely for the foreseeable future.
That doesn’t necessarily translate into additional revenue for Slack. To do that, the company will have to show that they are continuing to add customers, and there’s some question about that. For Slack to hit their projection of $873 million they will have to continue to beat their prior quarter. That’s not a guarantee, and that’s because of the second question that Slack will need to address.
How big is the threat from Microsoft?
Microsoft (NASDAQ:MSFT) is taking a full-on run at Slack with its Microsoft Teams software. In addition to capturing corporate clients, Teams is being integrated as part of many remote learning scenarios. And that’s not just at the university level. It’s also working its way into the secondary and even elementary school levels.
The good news for Slack is that Teams doesn’t represent an existential threat. Slack has a passionate user base. And once users are into the Slack ecosystem, it’s not a given that they will change. However, Microsoft is a threat that is not going away.
Can Slack repeat its positive free cash flow quarter?
Free cash flow (FCF) is an important measurement of a company’s financial health. This is particularly true of a company like Slack that is not reporting positive net income. In the last quarter, Slack reported positive free cash flow of $3.7 million. If Slack continues to increase its revenue, then it will logically follow that it will continue to increase its free cash flow. And when investors look at the stock of a company that is not yet profitable, like Slack, few things turn heads like increasing free cash flow.
The short-term may be rough for WORK stock.
This could easily be titled what a difference a week makes. If Slack was reporting one week earlier, the market was heading for record highs. Now it’s reporting in the middle of a tech-driven selloff. As we’ve seen in the past, these selloff’s tend to reverse themselves, but they can also last longer than investors have the stomach to take.
However, just like even the weakest tech stocks can rise in a bull market, many quality stocks can fall during a selloff. And that may be the case for Slack. Look for these fundamental measures when WORK stock reports. If you get confirmation of rising revenue, a protected moat against Microsoft, and increasing free cash flow, then Slack looks like a good buy despite its elevated valuation.
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