Splunk: Despite Rapid Growth, Neutral Outlook Remains

Shares in Splunk (NASDAQ:SPLK) have consensus rating is bullish and the consensus 12-month price target is 18.6% above the current share price.

Source: Investing.com

The Wall Street consensus outlooks from ETrade and from Investing.com are very consistent, with a bullish rating and a 12-month price target that implies about a 19.5% gain over the next year (averaging the two).

Market-Implied Outlook For SPLK

I have analyzed call and put options at a range of strike prices, all expiring on Jan. 21, 2022, to calculate the market-implied outlook for the next 3.4 months (from now until Jan. 21, 2022). I have also analyzed options expiring on Sept. 16, 2022 to calculate the market-implied outlook for the next 11.1 months.

I chose to analyze the January options because these are fairly highly traded and because they provide an outlook to early 2022. I chose the September options to provide an (almost) one year outlook. The options expiring in September are thinly traded, however, so there is little confidence in the market-implied outlook at this time horizon.

The standard presentation of the market-implied outlook is in the form of a probability distribution of price return, with probability on the vertical axis and return on the horizontal.

Source: Author’s calculations using options quotes from ETrade

The market-implied outlook for the next 3.4 months is generally symmetric, but the peak probabilities are tilted towards negative returns (a bearish indicator). The maximum probability corresponds to a price return of -8% for this period. The annualized volatility derived from this distribution is 41%, which is quite high for an individual stock. ETrade calculates a value of 39% for the implied volatility of the options expiring on Jan. 21, 2022.

To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).

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Source: Author’s calculations using options quotes from ETrade

From this view, it is evident that the probabilities of negative returns are consistently higher than for positive returns for a wide range of the most-probable outcomes (the red dashed curve is above the solid blue curve from 0% to about 25% on the horizontal axis on the chart above). The probability of very large positive returns is higher than for negative returns of the same magnitude (from 20% to 50% on the chart above), but the overall probability of these outcomes is low. This is a bearish market-implied outlook, although there is an asymmetric potential for a large upside surprise.

The market-implied outlook for next 11.1 months, calculated using options expiring in September, is not terribly robust due to the lack of active trading (so there are not a lot of participants expressing their implicit views). The market-implied outlook to September is an amplification of the bearish shorter-term outlook. The peak probability corresponds to a price return of about -26%. The annualized volatility derived from this distribution is 41%.

Source: Author's calculations using options quotes from ETrade

The chart above shows the market-implied price return probabilities for SPLK for the 11.1-month period from today until Sept. 16, 2022. The negative return side of the distribution has been rotated about the vertical axis.

The market-implied outlook for the next 3.4 months is bearish, with substantial volatility. The market-implied outlook for the next 11.1 months is also bearish, although the confidence in this longer-term outlook is low.

Summary

High stock price volatility often reflects rapidly-changing views on a company’s prospects and SPLK falls into this category. Differences of opinion on the stock are evident in the contrast between the Wall Street consensus outlook and the implicit consensus of options traders reflected in the market-implied outlook.

While the company is demonstrating rapid growth, valuation is challenging. Similar to when I analyzed SPLK in March, the Wall Street consensus is bullish and the market-implied outlook is bearish. The Wall Street consensus for the 12-month projected return has gotten lower, going from 47% in March to about 19.5% today, reflecting a less optimistic growth outlook.

As a rule of thumb for a buy rating, I look for expected 12-month return (19.5%, using the Wall Street consensus) that is at least ½ the projected volatility (41% from the market-implied outlook). Even taking the bullish Wall Street price target at face value, the expected return does not quite meet my criterion for an attractive risk/return balance. The market-implied outlook is bearish. I am maintaining my neutral rating on SPLK.

Written By: Geoff Considine, Ph.D