Don’t Chase the Monster Rally in DocuSign

• DOCU has roared 35% in three trading sessions following a strong Q3 earnings report
• But both valuation and growth remain a concern
• There was an opportunity to get DOCU on the dip; that opportunity seems to have passed

DocuSign (NASDAQ:DOCU) is finally showing signs of life. And there’s an irony to the fact that it’s been a strong earnings report that has led DOCU higher.

After all, it was weak earnings reports that sent the stock plummeting from August 2021 highs above $300 to lows this month near $40. Weakening sentiment toward tech stocks — and “pandemic winners” like DocuSign — certainly played a role, of course. But before the earnings release for the second quarter of fiscal 2023 back in September, here’s how DOCU had performed after its previous three quarterly reports:

• Q3 FY22: -42%
• Q4 FY22: -20%
• Q1 FY23: -32% (across two trading sessions)

But the company showed some promise in that Q2 release: shares rose double-digits. The gains didn’t hold, but the monster Q3 report has led to a huge rally. Over the last three sessions, DOCU has risen 35%.

Yet, as has been the case for the last sixteen months, there’s still plenty of reason for caution. Q3 earnings did offer some reason for optimism — but a 35% move in prices is an awful lot of that optimism.

No, DOCU Isn’t Cheap

We’ve been here before with DocuSign. As noted, the stock saw buying after the Q2 release — and promptly fell off the table, heading to new lows. The strength this week suggests a repeat of that trading isn’t necessarily likely, but it still leaves the stock in roughly the same position it’s been in before: cheaper, but not necessarily cheap.

Indeed, back in June, with DOCU around the same price, I highlighted some of the valuation concerns surrounding the stock. Six months later, the story sounds the same.

An enterprise value of $10 billion is roughly 4x this year’s revenue, seemingly a cheap multiple relative to large-cap tech peers. The company’s guidance suggests full-year adjusted earnings per share of roughly $1.90, implying a price-to-earnings multiple still below 30x. That, too, looks attractive in the context of what should be reasonably solid long-term growth.

But price-to-revenue is impacted by growth prospects — and DocuSign’s growth is actually below that of even more mature companies. More importantly, the adjusted EPS figure excludes stock-based compensation, which remains exceptionally high.

Stock-based comp has totaled nearly $400 million year-to-date, with an annual run rate in the range of $525 million. DocuSign is guiding for an adjusted operating income of $475 million. Account for the very real expense of stock issuance to employees, and the business is not even profitable at the moment.

Even after an admittedly strong quarter, one in which adjusted profit crushed analyst expectations, it’s still difficult to see DOCU as some kind of value stock. Quite a bit of growth remains priced in.

The Growth Problem

And the fact is that DocuSign really isn’t growing that quickly. Revenue increased 18% year-over-year in Q3, which sounds impressive. But billings — which account for new business in the quarter — rose at a modestly slower rate.

The outlook is much worse. The high end of billings guidance for the fourth quarter suggests year-over-year growth of just 6.7%. And as an analyst from Baird highlighted, on the third quarter conference call, DocuSign management projected low-single-digit billings growth in fiscal 2024.

To be sure, the slowing housing market is providing a short-term headwind. But even in that context, minimal top-line growth simply isn’t enough. Even the fact that the housing market can have such a significant impact shows how reliant the company remains on its core services.

It’s still possible that DocuSign can fine-tune its “land and expand” strategy and drive increased revenue from add-on products beyond digital signatures. The story here isn’t over, and DocuSign can’t be written off.

But that alone is not nearly enough to own DOCU stock at a still-high valuation. Right now, the market is pricing in growth; DocuSign management itself is saying that growth isn’t on the way. It seems unlikely that mismatch will wind up with the stock continuing to rally.

Disclosure: As of this writing, Vince Martin has no positions in any securities mentioned.