Q2 Holdings’s 16.8% return over the past six months has outpaced the S&P 500 by 9.1%, and its stock price has climbed to $62.20 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 Q2 Holdings, 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.
Why Is Q2 Holdings Not Exciting?
We’re glad investors have benefited from the price increase, but we’re passing on Q2 Holdings for now. Here are three reasons you should be careful with QTWO, plus one stock we’d rather own.
1. Weak Billings Point to Soft Demand
Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.
Q2 Holdings’s billings came in at $203.4 million in Q2, and over the last four quarters, its year-on-year growth averaged 7.7%. This performance was underwhelming and suggests that increasing competition is causing challenges in acquiring/retaining customers. 
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 Q2 Holdings’s revenue to rise by 9.6%, a deceleration versus its 13.2% annualized growth for the past five years. This projection doesn’t excite us and suggests its products and services will face some demand challenges.
3. Low Gross Margin Reveals Weak Structural Profitability
For software companies like Q2 Holdings, gross profit tells us how much money remains after paying for the base cost of products and services (typically servers, licenses, and certain personnel). These costs are usually low as a percentage of revenue, explaining why software is more lucrative than other sectors.
Q2 Holdings’s gross margin is substantially worse than most software businesses, signaling it has relatively high infrastructure costs compared to asset-lite businesses like ServiceNow. As you can see below, it averaged a 57% gross margin over the last year. Said differently, Q2 Holdings had to pay a chunky $43.01 to its service providers for every $100 in revenue.
The market not only cares about gross margin levels but also how they change over time because expansion creates firepower for profitability and free cash generation. Q2 Holdings has seen gross margins improve by 7.5 percentage points over the last 2 years, which is elite in the software space.
Final Judgment
Q2 Holdings isn’t a terrible business, but it doesn’t pass our bar. With its shares beating the market recently, the stock trades at 4.4× forward price-to-sales (or $62.20 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We’re pretty confident there are more exciting stocks to buy at the moment. We’d suggest looking at one of our all-time favorite software stocks.
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