Recent trading update 

The Q1 trading update was very poor for DocuSign and as a result, its share price sank around 23% on the day. This was due to very weak forward guidance and a miss on earnings. In fact, for Q2, the company has forecast that it will make revenues of around $600m, a rise of 17% from last year. For the full-year, revenue growth is ‘only’ expected to be around 18%. Considering that revenue growth last year was 45%, this is very disappointing. 

The firm also missed earnings expectations, reporting 38 cents per share on a non-GAAP basis, against Wall Street expectations of 46 cents per share. This illustrated that DocuSign isn’t immune to the macroeconomic challenges, and operating margins are a current struggle for the group. 

But I was still encouraged to see growth, especially considering that the pandemic has now mainly subsided. Indeed, the group was still able to add 70,000 customers in the period, taking the total to 1.24m. International revenues (outside of the US) also climbed 43% year-on-year and highlighted growth opportunities ahead. 

What am I doing with this Nasdaq stock?

After sinking 75%, DocuSign certainly looks a lot cheaper. In fact, based on forecast 2022 results, it now trades on a price-to-sales ratio of under five. During the pandemic, it traded at a price-to-sales ratio of over 30. It also trades at a price-to-earnings ratio of around 30, which is historically low. Therefore, any signs that operating margins are increasing could be met with major gains in the DocuSign share price. 

Growth could also be propelled by its expanded partnership with Microsoft. This may attract more consumers to start using the company’s products. 

But I’m still more tempted by other Nasdaq stocks, after the wider fall in the index. For instance, MercadoLibre trades at a lower price-to-sales ratio than DocuSign yet is still seeing revenue growth of over 60%. Its earning growth is also superior. Another example is Nvidia, which trades at a similar price-to-earnings ratio yet is growing at a faster rate. Nvidia has operating margins of over 40%, far higher than DocuSign. Therefore, although the DocuSign share price is historically cheap, I’m going to leave it on the sidelines for now. There are too many other great companies for me to choose from.

The recent volatility in the market is certainly unpleasant, making the relative stability of gold far more enticing. However, thanks to the price drops of many fantastic stocks, buying opportunities have likely emerged. So, how do I find them? Let’s explore.

The not-so-secret recipe of building wealth

In my experience, buying and holding shares in high-quality businesses that have a profound impact on improving the world is a recipe for sustainable wealth generation over the long term. This isn’t exactly a secret, and it’s something Warren Buffett has been saying for decades.

But simply identifying these companies is not enough. The price of the stock also needs to be taken into account, and the importance of valuation is something most investors tend to forget. All too often, a ground-breaking discovery or disruptive start-up makes headlines sending its share price surging. The prospect of a revolutionary product or service generates a lot of excitement. And that can push share prices to lofty levels. What’s more, investor growth expectations tend to grow even bigger as the share price climbs, especially if the company has a history of beating analysts’ forecasts.

But eventually, the price can become divorced from the underlying fundamentals. And when that happens, buying shares of even the most well-run enterprise can be a disastrous mistake. Why? Because all it takes is one sign of trouble or slowing growth to trigger massive downward momentum.

Investors of DocuSign know this all too well. The electronic signature solutions business saw its share price nearly halve in a single day last month after management issued guidance that was lower than analysts’ forecasts. I like to describe these situations as Fantastic Business, Terrible Stock.

Uncovering buying opportunities, Warren Buffett-style

Fortunately, such volatility can create buying opportunities. When any business releases an underwhelming earnings report or is at the centre of a negative news story, the share price has a habit of falling. And this happens regardless of whether the underlying value of the company is affected.

It’s not uncommon for a company to miss earnings expectations due to a temporary problem. In fact, the last two years have seen plenty of this as Covid-19 continues to disrupt entire industries. But the question to ask is, what caused the drop in performance?

Suppose it’s only a temporary problem, and the business itself is a well-run organisation with a strong balance sheet and fat cash flows? In that case, a buying opportunity for me may have just emerged thanks to investors falling prey to their emotions. Or, as Warren Buffett put it: “Be fearful when others are greedy, and greedy when others are fearful”.

The results clearly didn’t live up to the market’s expectations, and the shares repriced to reflect this. Let’s take a look to see if Docusign stock is now a bargain for my portfolio.

Docusign’s results

Docusign offers e-signature solutions for users through its cloud-based software suite. The pandemic created huge demand for its e-signature service when most people were working remotely.

The third-quarter results reflected this demand. Revenue grew 42% compared to the same period in fiscal year 2021 (the 12 months to 31 January 2021). Subscription revenue grew even quicker at 44%. The growth in revenue meant adjusted earnings per share surged to $0.58, which was up from $0.22 in the prior year. This is a spectacular growth rate in earnings of 164%.

All seems ok so far. But with any company, the stock is priced on future expectations. This is where Docusign’s update began to falter.

Docusign’s outlook

The key part was when management said: “After six quarters of accelerated growth, we saw customers return to more normalized buying patterns, resulting in 28% year-over-year billings growth.”

The company has recognised that the last six quarters have been excellent. But now, the guidance suggests that this hyper growth phase is over. It’s easy to understand why, as workers are beginning to return to the office.

The fact that the billings growth is slowing is a concerning sign. Billings includes sales that have been booked but not recognised as revenue yet, so it’s a forward-looking indicator for the business. 

The company then guided for fourth-quarter revenue of $560m (taking the midpoint in guidance). Consensus estimates before the update were for fourth-quarter revenue of $574m, so a fair amount higher than the company now expects.

The clear pattern here is that the company has benefited hugely over recent quarters and growth has been spectacular. But it looks like it won’t be in future.

Is Docusign stock a buy?

I think Docusign is a great business, and its software services will continue to be used from here regardless of the pandemic. It’s showing signs of being a quality stock too. The operating margin was 12.4% in fiscal year 2021, and management said this increased to 22% in the third-quarter results, exceeding expectations.

But it comes down to valuation for me. On a forward price-to-earnings ratio, the shares are valued on a multiple of 77. This is just too high for me to get interested, taking into account the slowing growth rate. Although the share price fell over 40% on Friday, I think it might decline further.

It’s not the first company that has released an update containing respectable growth, only for the forward guidance to disappoint. It seems that many US growth stocks are priced to continue on a hyper growth phase, so the outlook has to be strong to warrant the high valuation.

In summary, I think Docusign is a good business, and I might revisit the stock if it becomes cheaper.