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Q2 Holdings (QTWO): Buy, Sell, or Hold Post Q2 Earnings?

QTWO Cover Image

Over the past six months, Q2 Holdings’s shares (currently trading at $62.69) have posted a disappointing 16.4% loss, well below the S&P 500’s 27.3% gain. This might have investors contemplating their next move.

Is there a buying opportunity in Q2 Holdings, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free for active Edge members.

Why Is Q2 Holdings Not Exciting?

Despite the more favorable entry price, we're swiping left on Q2 Holdings for now. Here are three reasons you should be careful with QTWO and a stock we'd rather own.

1. Weak ARR Points to Soft Demand

While reported revenue for a software company can include low-margin items like implementation fees, annual recurring revenue (ARR) is a sum of the next 12 months of contracted revenue purely from software subscriptions, or the high-margin, predictable revenue streams that make SaaS businesses so valuable.

Q2 Holdings’s ARR came in at $861 million in Q2, and over the last four quarters, its year-on-year growth averaged 12%. This performance was underwhelming and suggests that increasing competition is causing challenges in securing longer-term commitments. Q2 Holdings Annual Recurring Revenue

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 11.2%, close to its 15.7% annualized growth for the past five years. This projection doesn't excite us and implies its newer products and services will not accelerate its top-line performance yet.

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 52.6% gross margin over the last year. That means Q2 Holdings paid its providers a lot of money ($47.38 for every $100 in revenue) to run its business.

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 5.8 percentage points over the last 2 year, which is elite in the software space.

Q2 Holdings Trailing 12-Month Gross Margin

Final Judgment

Q2 Holdings isn’t a terrible business, but it doesn’t pass our quality test. Following the recent decline, the stock trades at 5.3× forward price-to-sales (or $62.69 per share). While this valuation is reasonable, we don’t really see a big opportunity at the moment. We're pretty confident there are superior stocks to buy right now. Let us point you toward a top digital advertising platform riding the creator economy.

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