While large integrated technology giants are back in revenue growth mode, cloud software companies – especially small ones – have remained in defensive mode in 2023. But not all of them. Monday.com (MNDY -1.56%) has been an exception. The company dropped another excellent quarterly report on Monday morning, keeping the stock in the rally it has enjoyed for most of the last year.
The stock has risen over 50% in the last 12 months. Is it too late to buy?
Monday.com advantage
Monday.com is a small software company, but it has made a name for itself in its competitive industry with highly customizable software that can be used for everything from customer and sales management to project management. But as interest rates have risen in the past year as a result of the Fed’s fight against inflation, business spending has fallen, and Monday.com quickly turned to what investors want to see most from their small software stocks. Right now it’s not just sales growth, but a balance of growth and profitability.
On Monday, it reported third-quarter 2023 revenue of $189.2 million, up 38% from last year. And its GAAP operating loss improved to just $2.5 million, compared with an operating loss of $28.2 million in the year-ago quarter. Monday, however, switched to a GAAP net profit of $7.5 million in the quarter, a small consolation prize in a rising interest rate environment. That’s a result of the massive $1 billion in cash and short-term investments on the balance sheet that generate interest income for the company.
Free cash flow (FCF) was $65 million, good for an FCF margin of 34%, up from an FCF margin of just 10% in Q3 2022. Some of the difference between FCF and GAAP net income was $26.6 million in employee share-based compensation, which on Monday has been able to stay fairly flat year-over-year in an ongoing effort to keep total expenses in check.
Life is still tough for small software stocks
Of course, not everything is peachy on Monday. Just as many other cloud software companies have reported slowing growth, this one has. Monday customers themselves are also looking for ways to cut costs and save money, and that often means delaying the implementation of new software. Revenue expectations for Q4 ($196 million to $198 million) imply growth of at least 31% year-over-year. However, this outlook is a modest 4.8% sequential increase or a 19% year-over-year increase.
Put another way, Monday’s rapid growth may be coming to an end, at least for the time being.
It is therefore a good thing that the management has worked for the last year to get the profit margin in a range that will keep the shareholders happy. Building a profitable business early is an important task for small software companies that want to compete against giant competitors. Monday will need to build on its past success with additional product offerings to build a more robust network of partners and customers going forward.
With that in mind, it’s still best to be cautious with this stock. Monday has a premium valuation (40 times enterprise value to trailing 12-month FCF), which can cause wild swings in its share price from one quarter to the next. If you’re considering adding this small cloud software company to your basket of small and midcap stocks, nibble in small chunks or consider doing so using a dollar cost averaging strategy to accumulate a position over time.