Over the past six months, Sprout Social’s shares (currently trading at $8.58) have posted a disappointing 15.4% loss, well below the S&P 500’s 8.2% gain. This was partly driven by its softer quarterly results and may have investors wondering how to approach the situation.
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Why Is Sprout Social Not Exciting?
Despite the more favorable entry price, we’re swiping left on Sprout Social for now. Here are three reasons we avoid SPT, 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.
Sprout Social’s billings came in at $110.5 million in Q1, and over the last four quarters, its year-on-year growth averaged 9.6%. This performance was underwhelming and suggests that increasing competition is causing challenges in acquiring/retaining customers. 
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 6.9%, a deceleration versus its 26.8% annualized growth for the past five years. This projection doesn’t excite us and suggests its products and services will face some demand challenges.
3. Operating Losses Sound the Alarm
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 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 8.1% 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 quality test. After the recent drawdown, the stock trades at 1× forward price-to-sales (or $8.58 per share). While this valuation is reasonable, we don’t really see a big opportunity at the moment. We’re fairly confident there are better investments elsewhere. We’d suggest looking at one of our top software and edge computing picks.
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