What a brutal six months it’s been for Sprout Social. The stock has dropped 25% and now trades at $20.22, rattling many shareholders. This may have investors wondering how to approach the situation.
Is there a buying opportunity in Sprout Social, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Why Is Sprout Social Not Exciting?
Even with the cheaper entry price, we're sitting this one out for now. Here are two reasons why SPT doesn't excite us and a stock we'd rather own.
1. Operating Losses Sound the Alarms
While many software businesses point investors to their adjusted profits, which exclude stock-based compensation (SBC), we prefer GAAP operating margin because SBC is a legitimate expense used to attract and retain 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.
Sprout Social’s expensive cost structure has contributed to an average operating margin of negative 14.9% 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 be optimistic about its growth, but we have some doubts.
2. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
Sprout Social has shown mediocre cash profitability over the last year, giving the company limited opportunities to return capital to shareholders. Its free cash flow margin averaged 6.1%, subpar for a software business.
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 2.7× forward price-to-sales (or $20.22 per share). This valuation is reasonable, but the company’s shakier fundamentals present too much downside risk. We're pretty confident there are superior stocks to buy right now. We’d suggest looking at an all-weather company that owns household favorite Taco Bell.
Stocks We Would Buy Instead of Sprout Social
The market surged in 2024 and reached record highs after Donald Trump’s presidential victory in November, but questions about new economic policies are adding much uncertainty for 2025.
While the crowd speculates what might happen next, we’re homing in on the companies that can succeed regardless of the political or macroeconomic environment. Put yourself in the driver’s seat and build a durable portfolio by checking out our Top 5 Growth Stocks for this month. This is a curated list of our High Quality stocks that have generated a market-beating return of 175% over the last five years.
Stocks that made our list in 2019 include now familiar names such as Nvidia (+2,183% between December 2019 and December 2024) as well as under-the-radar businesses like Comfort Systems (+751% five-year return). Find your next big winner with StockStory today for free.
