What a brutal six months it’s been for Pegasystems. The stock has dropped 43.9% and now trades at $32.75, rattling many shareholders. This was partly driven by its softer quarterly results and might have investors contemplating their next move.
Is now the time to buy Pegasystems, or should you be careful about including it in your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Do We Think Pegasystems Will Underperform?
Despite the more favorable entry price, we’re cautious about Pegasystems. Here are three reasons we avoid PEGA, 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.
Pegasystems’s billings came in at $485.5 million in Q1, and over the last four quarters, its year-on-year growth averaged 5.1%. This performance was underwhelming and suggests that increasing competition is causing challenges in acquiring/retaining customers. 
2. Long Payback Periods Delay Returns
The customer acquisition cost (CAC) payback period represents the months required to recover the cost of acquiring a new customer. Essentially, it’s the break-even point for sales and marketing investments. A shorter CAC payback period is ideal, as it implies better returns on investment and business scalability.
Pegasystems’s recent customer acquisition efforts haven’t yielded returns as its CAC payback period was negative this quarter, meaning its incremental sales and marketing investments outpaced its revenue. The company’s inefficiency indicates it operates in a highly competitive environment where there is little differentiation between Pegasystems’s products and its peers.
3. Shrinking Operating Margin
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.
Analyzing the trend in its profitability, Pegasystems’s operating margin decreased by 6.3 percentage points over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its operating margin for the trailing 12 months was 10.2%.
Final Judgment
We see the value of companies addressing major business pain points, but in the case of Pegasystems, we’re out. After the recent drawdown, the stock trades at 2.9× forward price-to-sales (or $32.75 per share). While this valuation is reasonable, we don’t see a big opportunity at the moment. There are more exciting stocks to buy at the moment. Let us point you toward a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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