Investors Continue to Overpay for Splunk Inc (SPLK)

Even with Splunk Inc (NASDAQ:SPLK) trading down substantially from the recent market weakness, the stock is still very overvalued. The stock was one of the hottest IPOs in 2012 and recently hit all time highs while trading at ridiculously high multiples.

Splunk Inc (NASDAQ:SPLK) is a leading provider of software for real-time operational intelligence. The company forecast up to 38% revenue growth for the year, but is that growth enough to justify outlandish multiples?

Strong free cash flow

The impressive part with most software companies is the ability to generate strong free cash flow even while reporting accounting losses. In this case, Splunk Inc (NASDAQ:SPLK) generated $18.6 million of free cash flow in Q1 2014 on total revenue of only $57.2 million. While the company is quick to caution that Q1 and Q4 see higher levels of free cash flow, it is impressive to flow nearly 33% of revenue during any quarter.

For all of fiscal 2013, Splunk Inc (NASDAQ:SPLK) recorded $37.6 million of free cash flow on total revenue of $198.9 million. At this level, the stock trades at a whopping 117 times that free cash flow figure.

Decent results and guidance, but growth decelerating

When it comes to guidance for any stock, the returns following always depend on the expectations and eventually the valuations follow. In the case of Splunk Inc (NASDAQ:SPLK), the company was able to exceed expectations especially on a revenue basis. On a valuation basis, the stock should hit a wall soon. The company has a valuation of around $4.4 billion while only forecasting revenue to top out around $274 million this year. The stock currently trades at a revenue multiple of 16 times those expectations.

Not many stocks are able to maintain those valuations especially if revenue growth will slow from the 54% reported for Q1 2014 to the forecast for only 38% growth for this year. That decelerating revenue growth really hits over the next few quarters. The company hit 54% growth in Q1 followed by forecasts for 41% in Q2 and even lower analyst expectations for only 33% growth by Q3.

Relative valuations

In the case of what appears to be absurdly high valuations for Splunk, it is worth reviewing valuations of similar technology stocks. Other stocks including network security stock Palo Alto Networks Inc (NYSE:PANW) and recent business analytics software IPO Tableau Software, Inc. (NYSE:DATA) provide interesting insights into the market.