Will ServiceNow Earn or Burn?

Margins matter. The more ServiceNow (NYSE: NOW  ) keeps of each buck it earns in revenue, the more money it has to invest in growth, fund new strategic plans, or (gasp!) distribute to shareholders. Healthy margins often separate pretenders from the best stocks in the market. That's why we check up on margins at least once a quarter in this series. I'm looking for the absolute numbers, so I can compare them to current and potential competitors, and any trend that may tell me how strong ServiceNow's competitive position could be.

Here's the current margin snapshot for ServiceNow over the trailing 12 months: Gross margin is 57.3%, while operating margin is -15.4% and net margin is -15.3%.

Unfortunately, a look at the most recent numbers doesn't tell us much about where ServiceNow has been, or where it's going. A company with rising gross and operating margins often fuels its growth by increasing demand for its products. If it sells more units while keeping costs in check, its profitability increases. Conversely, a company with gross margins that inch downward over time is often losing out to competition, and possibly engaging in a race to the bottom on prices. If it can't make up for this problem by cutting costs -- and most companies can't -- then both the business and its shares face a decidedly bleak outlook.

Of course, over the short term, the kind of economic shocks we recently experienced can drastically affect a company's profitability. That's why I like to look at five fiscal years' worth of margins, along with the results for the trailing 12 months, the last fiscal year, and last fiscal quarter (LFQ). You can't always reach a hard conclusion about your company's health, but you can better understand what to expect, and what to watch.

Here's the margin picture for ServiceNow over the past few years.

Source: S&P Capital IQ. Dollar amounts in millions. FY = fiscal year. TTM = trailing 12 months.

Because of seasonality in some businesses, the numbers for the last period on the right -- the TTM figures -- aren't always comparable to the FY results preceding them. To compare quarterly margins to their prior-year levels, consult this chart.

Source: S&P Capital IQ. Dollar amounts in millions. FQ = fiscal quarter.

Here's how the stats break down:

• Over the past five years, gross margin peaked at 65.9% and averaged 61.4%. Operating margin peaked at 11.4% and averaged -21.0%. Net margin peaked at 10.6% and averaged -22.6%.
• TTM gross margin is 57.3%, 410 basis points worse than the five-year average. TTM operating margin is -15.4%, 560 basis points better than the five-year average. TTM net margin is -15.3%, 730 basis points better than the five-year average.

With recent TTM operating margins exceeding historical averages, but net margins still negative, ServiceNow still has some work to do.

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