Varonis Systems has been on fire lately. In the past six months alone, the company’s stock price has rocketed 51.4%, reaching $61.80 per share. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is there a buying opportunity in Varonis Systems, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free for active Edge members.
Why Is Varonis Systems Not Exciting?
We’re happy investors have made money, but we're cautious about Varonis Systems. Here are three reasons why VRNS doesn't excite us and a stock we'd rather own.
1. Lackluster Revenue Growth
Long-term growth is the most important, but within software, a stretched historical view may miss new innovations or demand cycles. Varonis Systems’s recent performance shows its demand has slowed as its annualized revenue growth of 10.4% over the last two years was below its five-year trend. 
2. Operating Losses Sound the Alarms
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.
Varonis Systems’s expensive cost structure has contributed to an average operating margin of negative 20.4% over the last year. Unprofitable, high-growth software companies require extra attention because they spend heaps of money to capture market share. As seen in its fast historical revenue growth, this strategy seems to have worked so far, but it’s unclear what would happen if Varonis Systems reeled back its investments. Wall Street seems to think it will face some obstacles, and we tend to agree.
3. Free Cash Flow Projections Disappoint
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Over the next year, analysts’ consensus estimates show they’re expecting Varonis Systems’s free cash flow margin of 20.8% for the last 12 months to remain the same.
Final Judgment
Varonis Systems isn’t a terrible business, but it doesn’t pass our quality test. After the recent surge, the stock trades at 10× forward price-to-sales (or $61.80 per share). Beauty is in the eye of the beholder, but we don’t really see a big opportunity at the moment. We're pretty confident there are superior stocks to buy right now. We’d recommend looking at a safe-and-steady industrials business benefiting from an upgrade cycle.
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