A simulation-based valuation of Workday (WDAY): July 2019

Summary

- WDAY was founded in 2005 as a human resources management software by former Peoplesoft pioneers.

- Its market capitalization was almost $49 billion at the time of this writing, and with an attractive balance sheet.

- In this post we provide a simulation-based (sim-based) valuation of WDAY.

- At the time of this writing the company had a negative net profit margin of -15% and a price-to-sales ratio of 16.19.

- Our sim-based analysis suggests a fair value of $194.48. WDAY currently trades at $215.50, so it appears slightly overvalued.

Workday (WDAY)

WDAY was founded in 2005 as a human resources management software company by former Peoplesoft pioneers. This happened after Peoplesoft was acquired by Oracle in a hostile takeover. Since then it has grown quickly. Its market capitalization was almost $49 billion at the time of this writing, and with an attractive balance sheet. For example, it is not leveraged at all, having more cash than debt.

Estimating a sim-PE

In this post we provide a simulation-based (sim-based) valuation () of WDAY.

At the time of this writing the company had a negative net profit margin of -15% and a price-to-sales ratio of 16.19. The growth in sales for the past 5 years has been a very high 43%. We will consider this to be the sim-based earnings growth rate for the next 5 years, which is a somewhat optimistic prediction given that the 5-year earnings growth forecast is 28%.

Taking the numbers above, we can arrive at a sim-based valuation by making a few additional assumptions. One of these assumptions is a net profit margin of 24%, which is the average for information technology services companies. With this, and the price-to-sales ratio above, we arrive at a sim-based price-to-earnings ratio of 67.46.

Note that we assumed a positive net profit margin of 24% for a company that actually has a net profit margin of -15%. This type of assumption is useful in valuing companies that have a negative profit margin, which is often the case with high-growth companies that have been publicly-traded for only a few years.

Estimating a fair value for the stock

Is the sim-based price-to-earnings ratio of 67.46 suggestive of overvaluation? As you can see in the table below, the answer to this question is “yes”. Since our sim-based analysis uses a S&P 500 return as a basis, the price-to-earnings ratio should be 60.88, leading to a current fair value of $194.48. WDAY currently trades at $215.50, so it appears slightly overvalued.

What if future earnings growth is more in line with forecasts?

As noted above, we used as sim-based earnings growth rate for the next 5 years the growth in sales for the past 5 years, which has been a very high 43%.

What would happen if we used the 5-year earnings growth forecast of 28%? In that case, as shown in the table below, the price-to-earnings ratio should be 29.37, leading to a current fair value of $93.84. This highlights the key challenge of valuing growth stocks - growth forecasts can vary widely.

Keep in mind that the company could grow even faster at the top and bottom lines, which would suggest that it is currently undervalued. I would think this to be unlikely since sales growth has been slowing down as of late.

Disclosure

I do not own WDAY shares at the time of this writing, nor do I intend to buy shares within the next 72 hours.