By Bruce Murray, CFA
Artificial intelligence is changing the landscape but the fundamentals still matter.
Artificial intelligence continues to reshape enterprise software. New products, new competitors and new expectations are changing how investors evaluate the sector. During periods like these, we find it helpful to focus less on predictions and more on measurable business fundamentals. Companies that continue to strengthen customer relationships, grow recurring revenue and allocate capital responsibly often stand apart over time.
ServiceNow is one of our portfolio holdings that we continue to follow closely. Since its founding in 2004, the company has evolved from an IT workflow platform into an enterprise platform supporting information technology, customer service, finance, human resources, security and risk management. Today it serves more than 8,800 customers worldwide, including more than 85 percent of Fortune 500 companies. Its breadth across enterprise functions provides insight into how organizations are adopting software beyond a single department.
One of the first characteristics we monitor is whether existing customers continue to deepen their relationship with a business. Figure 1 illustrates this trend. Rather than relying solely on new customer acquisition, ServiceNow has continued to expand revenue from organizations already using the platform. That is often a more durable source of long-term growth because it reflects customers finding additional value after implementation.
FIGURE 1. ServiceNow Customer Cohort Analysis
Source: ServiceNow
The same pattern appears in the company’s largest customer relationships. Customers generating more than US$5 million in annual contract value increased from 434 in the first quarter of 2024 to 630 in the first quarter of 2026. Average annual contract value within that group also increased. Together, those observations suggest customers continue to broaden their use of the platform over time rather than simply renewing existing contracts.
When evaluating software companies, recurring revenue is often more informative than revenue growth alone. Subscription businesses generally provide greater visibility into future cash flow, particularly when renewal rates remain high and customers continue expanding their use of the platform.
Subscription revenue increased 22 percent year over year to US$3.67 billion during the first quarter of fiscal 2026. Remaining Performance Obligations increased 25 percent to US$27.7 billion, while renewal rates remained between 97 and 98 percent over the past five quarters. Viewed together, these measures indicate continued demand from existing customers and provide greater visibility into future contracted revenue.
Artificial intelligence is now becoming another extension of the platform. Rather than positioning AI as a standalone product, ServiceNow has integrated AI capabilities into existing workflows while maintaining an open architecture capable of working with multiple AI models. Management also increased its Now Assist contract target from US$1 billion to US$1.5 billion, indicating continued customer adoption of AI-enabled workflows.
Financial performance has also remained consistent. Figure 3 shows revenue growth alongside improving profitability. During the first quarter, non-GAAP operating margins reached 32 percent while free cash flow margins reached 44 percent. Management also increased fiscal 2026 subscription revenue guidance to between US$15.735 billion and US$15.775 billion. These observations suggest the company continues to grow while maintaining operating discipline.
Growth, however, is only one part of the picture. We also pay close attention to how management allocates capital. Expanding free cash flow gives companies greater flexibility to invest in innovation, pursue acquisitions and return capital to shareholders when appropriate.
As free cash flow has increased, ServiceNow has continued investing in product development, completed strategic acquisitions and expanded its share repurchase program. The recent acquisition of Armis broadens the company’s security capabilities, although management has acknowledged modest near-term pressure on margins while the integration is completed. Those are the types of trade-offs we continue to monitor.
Valuation remains an important part of our process. A high-quality business does not necessarily represent an attractive investment if expectations have become excessive. Today, ServiceNow trades at approximately 24 times forward earnings with expected earnings growth of roughly 21 percent and a PEG ratio near 1.15. Those measures are lower than investors were willing to pay when the shares traded at previous highs despite continued growth in revenue, earnings and free cash flow.
Like every company we follow, ServiceNow faces risks. Integration of recent acquisitions, foreign exchange movements, enterprise spending cycles and continued competition across enterprise AI all warrant ongoing observation. None of these factors can be viewed in isolation, which is why we continue to evaluate the business using a consistent framework rather than any single metric.
Our investment process is built on observation rather than prediction. We look for evidence that customer relationships are strengthening, recurring revenue is expanding, profitability is improving and capital is being allocated responsibly. ServiceNow continues to demonstrate many of those characteristics. That does not eliminate investment risk or predict future returns. It does explain why the company continues to merit our attention.
