The past six months have been a windfall for Sprout Social’s shareholders. The company’s stock price has jumped 41%, hitting $9.86 per share. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is now the time to buy Sprout Social, or should you be careful about including it in your portfolio? See what our analysts have to say in our full research report, it’s free.
Why Is Sprout Social Not Exciting?
Despite the momentum, we’re cautious about Sprout Social. Here are three reasons why SPT doesn’t excite us, plus one 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.
Sprout Social’s ARR came in at $506.6 million in Q2, and over the last four quarters, its year-on-year growth averaged 10.1%. 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 Sprout Social’s revenue to rise by 5.3%, a deceleration versus its 25.2% annualized growth for the past five years. This projection is underwhelming and implies its products and services will face some demand challenges.
3. Operating Losses Sound the Alarm
While many software businesses point investors to their adjusted profits, which exclude stock-based compensation (SBC), we prefer GAAP operating margin because SBC is a legitimate expense used to attract and retain talent. This metric shows how much revenue remains after accounting for all core expenses — everything from the cost of goods sold to sales and R&D.
Sprout Social’s expensive cost structure has contributed to an average operating margin of negative 5.9% over the last year. Unprofitable, high-growth software companies require extra attention because they spend heaps of money to capture market share. As seen in its fast historical revenue growth, this strategy seems to have worked so far, but it’s unclear what would happen if Sprout Social reeled back its investments. Wall Street seems to think it will face some obstacles, and we tend to agree.
Final Judgment
Sprout Social isn’t a terrible business, but it doesn’t pass our bar. After the recent surge, the stock trades at 1.2× forward price-to-sales (or $9.86 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We’re pretty confident there are more exciting stocks to buy at the moment. We’d suggest looking at one of our all-time favorite software stocks.
Stocks We Would Buy Instead of Sprout Social
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