What a brutal six months it’s been for Pegasystems. The stock has dropped 42.2% and now trades at $28.50, rattling many shareholders. This was partly driven by its softer quarterly results and might have investors contemplating their next move.
Is now the time to buy Pegasystems, or should you be careful about including it in your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Do We Think Pegasystems Will Underperform?
Even with the cheaper entry price, we don’t have much confidence in Pegasystems. Here are three reasons why PEGA doesn’t excite us, plus one stock we’d rather own.
1. Weak Billings Point to Soft Demand
Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.
Pegasystems’s billings came in at $321.4 million in Q2, and over the last four quarters, its year-on-year growth averaged 3.6%. This performance was underwhelming and suggests that increasing competition is causing challenges in acquiring/retaining customers. 
2. Long Payback Periods Delay Returns
The customer acquisition cost (CAC) payback period measures the months a company needs to recoup the money spent on acquiring a new customer. This metric helps assess how quickly a business can break even on its sales and marketing investments.
Pegasystems’s recent customer acquisition efforts haven’t yielded returns as its CAC payback period was negative this quarter, meaning its incremental sales and marketing investments outpaced its revenue. The company’s inefficiency indicates it operates in a highly competitive environment where there is little differentiation between Pegasystems’s products and its peers.
3. Shrinking Operating Margin
Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This is one of the best measures of profitability because it shows how much money a company takes home after developing, marketing, and selling its products.
Looking at the trend in its profitability, Pegasystems’s operating margin decreased by 6.5 percentage points over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its operating margin for the trailing 12 months was 9.9%.
Final Judgment
We see the value of companies addressing major business pain points, but in the case of Pegasystems, we’re out. Following the recent decline, the stock trades at 2.4× forward price-to-sales (or $28.50 per share). This valuation is reasonable, but the company’s shaky fundamentals present too much downside risk. There are superior stocks to buy right now. Let us point you toward one of our top software and edge computing picks.
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