Over the past six months, Varonis Systems’s stock price fell to $28.75. Shareholders have lost 8.4% of their capital, which is disappointing considering the S&P 500 has climbed by 13.2%. This may have investors wondering how to approach the situation.
Is there a buying opportunity in Varonis Systems, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Do We Think Varonis Systems Will Underperform?
Even though the stock has become cheaper, we're swiping left on Varonis Systems for now. Here are three reasons why VRNS doesn't excite us and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
Reviewing a company’s long-term sales performance reveals insights into its quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years. Over the last five years, Varonis Systems grew its sales at a 16.1% annual rate. Although this growth is acceptable on an absolute basis, it fell slightly short of our standards for the software sector, which enjoys a number of secular tailwinds.
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.
Varonis Systems’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 competitive market and must continue investing to grow.
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 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.
Analyzing the trend in its profitability, Varonis Systems’s operating margin decreased by 2.5 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. Varonis Systems’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was negative 22.3%.
Final Judgment
We cheer for all companies solving complex business issues, but in the case of Varonis Systems, we’ll be cheering from the sidelines. After the recent drawdown, the stock trades at 4.3× forward price-to-sales (or $28.75 per share). This valuation tells us a lot of optimism is priced in - we think other companies feature superior fundamentals at the moment. We’d suggest looking at a dominant Aerospace business that has perfected its M&A strategy.
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