Rapid7 has been on fire lately. In the past six months alone, the company’s stock price has rocketed 91.4%, reaching $11.98 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.

Is there a buying opportunity in Rapid7, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.

Why Do We Think Rapid7 Will Underperform?

We’re glad investors have benefited from the price increase, but we’re sitting this one out for now. Here are three reasons you should be careful with RPD, plus one stock we’d rather own.

1. Declining Billings Reflect Product and Sales Weakness

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.

Rapid7’s billings came in at $202.6 million in Q2, and it averaged 2.7% year-on-year declines over the last four quarters. This performance was underwhelming and shows the company faced challenges in acquiring and retaining customers. It also suggests there may be increasing competition or market saturation.

2. Long Payback Periods Delay Returns

The customer acquisition cost (CAC) payback period measures the months a company needs to recoup the money spent on acquiring a new customer. This metric helps assess how quickly a business can break even on its sales and marketing investments.

Rapid7’s recent customer acquisition efforts haven’t yielded returns as its CAC payback period was negative this quarter, meaning its incremental sales and marketing investments outpaced its revenue. The company’s inefficiency indicates it operates in a highly competitive environment where there is little differentiation between Rapid7’s products and its peers.

3. 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, Rapid7’s operating margin decreased by 1.5 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. Its operating margin for the trailing 12 months was 1.2%.

Final Judgment

Rapid7 doesn’t pass our quality test. Following the recent rally, the stock trades at 1.1× forward price-to-sales (or $11.98 per share). This valuation tells us a lot of optimism is priced in - we think other companies feature superior fundamentals at the moment. Let us point you toward the Amazon and PayPal of Latin America.

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