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3 Stocks to Buy if They Take a Dip

Motley Fool - Wed Dec 20, 2023

Many investors may have missed the boat on great stocks that have charged higher this year. The recent market rally has focused on high-quality companies, driving some valuations into uncertain territory. These three stocks are primed for long-term performance, and investors should take a look if their valuations dip into a more reasonable range.

1. Veeva Systems

Veeva Systems(NYSE: VEEV) is a leading cloud software platform for the life sciences industry. Its products are used by more than 1,000 customers of all sizes in the pharmaceutical, biotechnology, diagnostics, and related businesses. The cloud platform supports a wide range of critical functions, including sales, customer communications, drug development, clinical trial management, and regulatory compliance.

A graph with a bullseye on a chalkboard that compares risk and reward.

Image source: Getty Images.

The quality and breadth of Veeva's product portfolio, along with high switching costs, make it very difficult for competitors to take market share in this niche. The focus on a highly specialized industry also provides Veeva with an advantage over more generalized potential competitors, such as SAP(NYSE: SAP), Oracle(NYSE: ORCL) or Salesforce(NYSE: CRM). These factors create a wide economic moat for Veeva Systems, which should support future growth and profit margin stability.

The business fundamentals look great, but the cloud software stock's valuation isn't so enticing. Its forward price-to-earnings (P/E) ratio is just under 44, but Veeva's growth rate doesn't seem to support that price. The company's sales grew 12% last quarter although earnings outpaced the top line.

The company's recent results have been impacted by a change in the company's contract terms and revenue recognition. That change is expected to reduce the top line by roughly 4% this year -- that's meaningful but not transformative. Veeva's guidance for next year suggests that growth should stay roughly where it is now after adjusting for that revenue recognition change.

There's nothing wrong with a 15% to 20% annual growth rate, but the forward P/E ratio looks a bit high relative to that number, especially if we consider that the company's sales have been slowing for a few years. The market price assumes that things will pick up as the macro environment improves and Veeva enters lucrative new markets. That sort of speculation comes with risk.

It's hard to knock the company's operational performance -- the stock's valuation just needs to reflect the evolving trajectory. If its forward P/E ratio dropped into the 35 range, then it would create some major upside potential and take some of the risk off the table.

2. ServiceNow

ServiceNow(NYSE: NOW) provides cloud-based IT workflow management software. It helps customers identify and address issues and track these processes across the organization.

The company's platform is heavily embedded among enterprises – roughly 85% of the S&P 500 are customers, and it has roughly 40% market share. Like Veeva systems, ServiceNow covers a variety of critical functions that come with high switching costs. This causes customers to stick around, and the company has consistently expanded customer relationships by beefing up its offering.

ServiceNow is growing at roughly 25% annually, and it's producing a ton of cash along the way. The company expects to produce more than $2.5 billion in free cash flow this year on $8.6 billion of revenue. ServiceNow has repeatedly exceeded Wall Street's expectations and its own forecasts.

These all make for a compelling investment narrative, but that's created a risk-reward imbalance. The stock is up nearly 80% year to date, driving its forward P/E ratio close to 60. That's not an outrageous premium for a company with ServiceNow's prospects, but the stock would be very hard to ignore if its valuation came down a bit.

3. CrowdStrike

CrowdStrike(NASDAQ: CRWD) is an endpoint cybersecurity leader that's ranked among the best-in-class for its offering. The company's economic moat is hard to confirm, thanks to a highly competitive, rapidly evolving, and heavily fragmented industry. However, CrowdStrike is consistently taking market share while adding functionality to its platform. The company is also delivering consistently high revenue retention, indicating strong customer satisfaction and a "sticky" product that's difficult for customers to cast aside.

CrowdStrike reported impressive 35% revenue growth last quarter. Perhaps more importantly, the company swung into profitability while producing nearly $800 million of free cash flow for the full fiscal year. That's admirable performance in a difficult economic environment, and it shows that company management is able to drive operational efficiency without sacrificing too much growth potential.

That said, CrowdStrike's growth rate is steadily declining as the company's scale inflates and it penetrates its target market. Demand should stay robust in the long term for endpoint security, but it's getting more challenging for CrowdStrike to replicate its excellent results year after year.

CRWD Revenue (Quarterly YoY Growth) Chart

CRWD Revenue (Quarterly YOY Growth) data by YCharts.

The cybersecurity stock's forward P/E ratio is over 60 now that the stock has rallied throughout 2023. That results in a price/earnings-to-growth ratio below 2.0, which suggests that it's reasonably priced relative to its growth rate. However, that assumes continued strong performance, which creates investment risk.

If CrowdStrike stock dips due to short-term uncertainty or weaker-than-expected results, this could become a great long-term opportunity for patient growth investors.

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Ryan Downie has positions in Salesforce and Veeva Systems. The Motley Fool has positions in and recommends CrowdStrike, Oracle, Salesforce, ServiceNow, and Veeva Systems. The Motley Fool has a disclosure policy.

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