Elastic currently trades at $77 per share and has shown little upside over the past six months, posting a small loss of 3%. However, the stock is beating the S&P 500’s 11% decline during that period.

Is now the time to buy Elastic, or should you be careful about including it in your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.

Even with the strong relative performance, we're swiping left on Elastic for now. Here are two reasons why there are better opportunities than ESTC and a stock we'd rather own.

Why Is Elastic Not Exciting?

Started by Shay Banon as a search engine for his wife's growing list of recipes at Le Cordon Bleu cooking school in Paris, Elastic (NYSE:ESTC) helps companies integrate search into their products and monitor their cloud infrastructure.

1. Operating Losses Sound the Alarms

Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales 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.

Elastic’s expensive cost structure has contributed to an average operating margin of negative 6.2% over the last year. Unprofitable, high-growth software companies require extra attention because they spend heaps of money to capture market share. As seen in its fast historical revenue growth, this strategy seems to have worked so far, but it’s unclear what would happen if Elastic reeled back its investments. Wall Street seems to be optimistic about its growth, but we have some doubts.

2. Cash Flow Margin Set to Decline

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

Over the next year, analysts predict Elastic’s cash conversion will fall. Their consensus estimates imply its free cash flow margin of 16.6% for the last 12 months will decrease to 14.8%.

Final Judgment

Elastic’s business quality ultimately falls short of our standards. Following its recent outperformance in a weaker market environment, the stock trades at 4.9× forward price-to-sales (or $77 per share). Investors with a higher risk tolerance might like the company, but we think the potential downside is too great. We're fairly confident there are better stocks to buy right now. Let us point you toward our favorite semiconductor picks and shovels play.

Stocks We Would Buy Instead of Elastic

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