Best SaaS Stock: Salesforce vs. ServiceNow

Over the past two decades, a growing number of companies have replaced their on-premises software with cloud-based subscription services. These software-as-a-service (SaaS) solutions allow software vendors to generate stable recurring revenue from their customers instead of relying on periodic upgrades. They also benefit customers with growing businesses, as it is easier to scale these services across a large number of devices.

Selling power (RCMP -1.22% ) and ServiceNow ( NOW -0.27% ) have both profited from this age-old trend. Salesforce, which was founded in 1999, is the world’s largest provider of cloud-based customer relationship management (CRM) services. ServiceNow, founded in 2003, optimizes an organization’s digital workflows with its cloud-based tools.

Image source: Getty Images.

Over the past five years, Salesforce shares have risen more than 130%, but ServiceNow has had a much bigger gain of almost 500%. Let’s see why ServiceNow has outperformed Salesforce and whether or not it will sustain this momentum and remain the strongest SaaS stock.

Which company grows faster?

Between fiscal 2017 and fiscal 2022 (which ended in January), Salesforce’s annual revenue grew at a compound annual growth rate (CAGR) of 25.9% to reach 26.5 billions of dollars. These robust returns were driven by organic growth in its core CRM business and inorganic expansion in its sales, marketing, e-commerce and analytics cloud services.

Salesforce expects annual revenue to exceed $50 billion in fiscal year 2026, which would represent a CAGR of at least 17.4% over the next four years. It expects the stable growth of the CRM market and the expansion of its adjacent cloud services – which will serve the ongoing digitization of a wide range of industries – to propel it towards this goal.

ServiceNow’s annual revenue grew at a CAGR of 33.1% to $5.8 billion from fiscal year 2016 to fiscal year 2021 (which is calendar year). It has significantly expanded its ecosystem with more than a dozen acquisitions during this period and has benefited from the growing demand for digital workflow services as companies rely more on remote and hybrid workers.

The company expects to generate more than $15 billion in annual revenue in 2026, which would represent a CAGR of at least 20.9% over the next five years. In his most recent conference call, CEO Bill McDermott said the company’s “organic growth machine is in full flight” and would not need to rely on new mergers and acquisitions (M&A ) for future growth.

Which company is the most profitable?

In addition to similar revenue growth, the two companies generate comparable gross margins. Salesforce ended fiscal 2022 with a gross margin of 73%, up from 74% a year earlier. ServiceNow’s gross margin also fell one percentage point to 77% in 2021.

Unlike many other small SaaS companies, Salesforce and ServiceNow are profitable on both generally accepted accounting principles (GAAP) and non-GAAP measures. However, ServiceNow has consistently generated stronger non-GAAP earnings growth than Salesforce.

Over the past five years, Salesforce has grown its non-GAAP earnings per share (EPS) at a CAGR of 36.5%, but ServiceNow’s non-GAAP EPS has grown at a much higher CAGR of 53.3% . Analysts expect this trend to continue.

Non-GAAP EPS growth (estimated)

Current fiscal year

Next fiscal year

Selling power

(2.7%)

24.1%

ServiceNow

24.3%

26.7%

Data source: Yahoo Finance, April 8. Chart by author.

Salesforce’s earnings are expected to fall this year as it integrates its latest acquisitions and faces tougher currency and tax headwinds. ServiceNow doesn’t need to deal with short-term acquisition costs and doesn’t face as many currency or tax challenges.

But one of these SaaS stocks is much more expensive

If we only look at their revenue, margins, and profit, ServiceNow seems like a slightly better investment than Salesforce.

However, ServiceNow shares are also trading at 79 times forward earnings and 14 times sales this year. Salesforce is trading at 47 times forward earnings and just six times sales this year. That’s a low price-to-sales ratio for a company that aims to nearly double its annual revenue over the next five years. For reference, Adobe — another SaaS peer growing at a slower rate than Salesforce — is trading at 12 times this year’s sales.

The winner: Salesforce

I like both of these SaaS stocks, but rising interest rates and other macro headwinds will likely make more expensive stocks like ServiceNow less attractive than more reasonably priced ones like Salesforce. Therefore, I think investors can safely buy Salesforce stock today, but they should wait for ServiceNow to cool down before pulling the trigger.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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