What a time it’s been for Freshworks. In the past six months alone, the company’s stock price has increased by a massive 84.2%, reaching $15.36 per share. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is it too late to buy FRSH? Find out in our full research report, it’s free.
Why does FRSH stock spark debate?
Starting as a customer service solution before expanding into a comprehensive software suite, Freshworks (NASDAQ: FRSH) provides AI-powered software-as-a-service solutions that help companies manage customer service, IT support, sales, and marketing functions.
Two positive attributes:
1. Long-term revenue growth shows strong momentum
A company’s long-term performance is an indicator of its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Over the last five years, Freshworks grew its sales at a solid 24% compounded annual growth rate. Its growth surpassed the average software company and shows its offerings resonate with customers.
2. Elite gross margin powers best-in-class business model
What makes the software-as-a-service model so attractive is that once the software is developed, it usually doesn’t cost much to provide it as an ongoing service. These minimal costs can include servers, licenses, and certain personnel.
Freshworks’s gross margin is one of the highest in the software sector, an output of its asset-lite business model and strong pricing power. It also enables the company to fund large investments in new products and sales during periods of rapid growth to achieve outsized profits at scale. As you can see below, it averaged an elite 85% gross margin over the last year. That means Freshworks only paid its providers $15.04 for every $100 in revenue.
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. Freshworks has seen gross margins improve by 1.4 percentage points over the last 2 years, which is solid in the software space.
One reason to be careful:
Customer churn hurts long-term outlook
One of the best parts about the software-as-a-service business model (and a reason why they trade at high valuation multiples) is that customers typically spend more on a company’s products and services over time.
Freshworks’s net revenue retention rate, a key performance metric measuring how much money existing customers from a year ago are spending today, was 104% in Q2. This means Freshworks would’ve grown its revenue by 4% even if it didn’t win any new customers over the last 12 months.
Freshworks has an adequate net retention rate, showing us that it generally keeps customers but lags behind the best SaaS businesses, which routinely post net retention rates of 120%+.
Final judgment
Freshworks has huge potential even though it has some open questions, and after the recent rally, the stock trades at 4.1× forward price-to-sales (or $15.36 per share). Is now a good time to buy? See for yourself in our comprehensive research report, it’s free.
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