3 Reasons to Avoid VRNS and 1 Stock to Buy Instead

Varonis Systems’s stock price has taken a beating over the past six months, shedding 61.5% of its value and falling to $24.25 per share. This might have investors contemplating their next move.

Is there a buying opportunity in Varonis Systems, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.

Why Is Varonis Systems Not Exciting?

Even though the stock has become cheaper, we're sitting this one out for now. Here are three reasons you should be careful with VRNS and a stock we'd rather own.

1. Long-Term Revenue Growth Disappoints

A company’s long-term performance is an indicator of its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Over the last five years, Varonis Systems grew its sales at a 16.3% annual rate. Although this growth is acceptable on an absolute basis, it fell slightly short of our standards for the software sector, which enjoys a number of secular tailwinds.

2. Shrinking Operating Margin

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 is one of the best measures of profitability because it shows how much money a company takes home after developing, marketing, and selling its products.

Looking at the trend in its profitability, Varonis Systems’s operating margin decreased by 2.1 percentage points over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Varonis Systems’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was negative 23.5%.

3. Cash Flow Margin Set to Decline

If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.

Over the next year, analysts predict Varonis Systems’s cash conversion will fall. Their consensus estimates imply its free cash flow margin of 21.2% for the last 12 months will decrease to 15.8%.

Final Judgment

Varonis Systems isn’t a terrible business, but it doesn’t pass our quality test. After the recent drawdown, the stock trades at 3.9× forward price-to-sales (or $24.25 per share). This valuation is reasonable, but the company’s shakier fundamentals present too much downside risk. We're pretty confident there are more exciting stocks to buy at the moment. We’d recommend looking at the Amazon and PayPal of Latin America.

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