Over the past six months, F5’s shares (currently trading at $274.66) have posted a disappointing 14.4% loss, well below the S&P 500’s 10.2% gain. This may have investors wondering how to approach the situation.

Is now the time to buy F5, or should you be careful about including it in your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.

Why Do We Think F5 Will Underperform?

Despite the more favorable entry price, we're cautious about F5. Here are three reasons there are better opportunities than FFIV and a stock we'd rather own.

1. Recurring Revenue Slipping as ARR Falls

While reported revenue for a software company can include low-margin items like implementation fees, annual recurring revenue (ARR) is a sum of the next 12 months of contracted revenue purely from software subscriptions, or the high-margin, predictable revenue streams that make SaaS businesses so valuable.

F5’s ARR came in at $190 million in Q4, and it averaged 7.1% year-on-year declines over the last four quarters. This performance was underwhelming, showing the company lost long-term deals and renewals. It also suggests there may be increasing competition or market saturation.

2. Projected Revenue Growth Is Slim

Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.

Over the next 12 months, sell-side analysts expect F5’s revenue to rise by 4.5%, close to its 5.4% annualized growth for the past five years. This projection is underwhelming and implies its newer products and services will not lead to better top-line performance yet.

3. Operating Margin in Limbo

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 metric shows how much revenue remains after accounting for all core expenses – everything from the cost of goods sold to sales and R&D.

Looking at the trend in its profitability, F5’s operating margin might fluctuated slightly but has generally stayed the same 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 24.7%.

Final Judgment

We see the value of companies addressing major business pain points, but in the case of F5, we’re out. After the recent drawdown, the stock trades at 5× forward price-to-sales (or $274.66 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think there are better stocks to buy right now. We’d recommend looking at one of our top digital advertising picks.

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