Sprout Social

Though Sprout Social Inc appears cheap due to heavy downward pressure in the past year, we have capped its rating at 3 stars to factor in the possibility that it represents a value trap. The stock currently trades at a 21% discount to our quantitative fair value estimate of $13.30 per share; however, caution is warranted due to this estimate's high uncertainty rating.

The company's balance sheet increases our quantitative valuation. Leverage can enable a company to invest in growth, potentially boosting shareholder value more than equity financing alone. For example, the firm's EBITDA/interest coverage ratio of -5.2 falls in the bottom 10% compared with global peers. Although the firm's ability to cover interest payments with EBITDA is limited, shares could sharply rebound if economic circumstances change or recent investments reduce fears of default. We believe this is a sign that shares could be cheap.

The company's valuation metrics are an additional encouraging factor. A company's valuation metrics provide insights into the market's expectations for its future growth and profitability. The firm's enterprise value to revenue ratio of 1.1, a core component of valuation, falls in the bottom 30% compared with global peers. The prevailing enterprise value/sales ratio is low relative to the long-term earnings power of the business. This characteristic further promotes our favorable price/fair value ratio.

With its quantitative economic moat rating of none, this business is unlikely to consistently outearn its cost of capital without structural protection from competition. Additionally, the firm's moderate financial health score suggests it is acceptably positioned against adverse economic circumstances.