Since the stock market has been turning negative in recent months, it’s important to try to put things in historical context. Investors have seen shares of many companies cut by half or more. This happens occasionally. Some deserve it. Others have good businesses in fast -growing industries.
Software-as-a-Service (SaaS) stocks are an example. Although values are lower, businesses continue to perform well. That’s why I thought it would be useful to look back a decade at previously high-flying SaaS stocks-first, to see if they also experienced a significant drop in price-to-sales (P/S). ratio, and second, to see if their growth has been able to overcome the valuation crunch and make them good investments in the long run.
Here is what I found.
Photo source: Getty Images.
A wonderful team
Five of the most high-profile-and expensive-tech stocks to be made public in 2012 are Working day (WDAY -3.41%), Splunk (SPLK -1.57%), Palo Alto Networks (PANW -2.45%)at Service Today (NOW -0.55%). Accordingly, they offer software to manage and evaluate human capital, machine data, cybersecurity, and information technology workflows. The largest initial public offering (IPO) of 2012 was Meta Platforms (FB 0.43%) – Facebook was just then. It’s not SaaS, but it’s included in any review of 2012 IPOs.
Making a fairly similar group of tech companies that have gone public over the past few years is not difficult. We will compare the group in 2012 to Snowflake (NIYEBE -0.75%), CrowdStrike (CRWD -2.09%), DataDog (DDOG -4.42%), Cloudflare (NET -0.26%)at MongoDB (MDB -4.41%). Let’s compare the numbers.
Growing in their appreciation
If we are to make a comparison with the past, we first need to establish how expensive the stocks are. We will use the beginning of 2013 – the year after their IPO – as a starting point to find their maximum value.
| company | Peak P/S Ratio |
|---|---|
| Working day | 42 |
| Splunk | 33 |
| Palo Alto Networks | 19 |
| Service Today | 27 |
| Meta Platforms | 23 |
Data source: YCharts.
They are all growing sales between 50% and 90% per year. That’s similar to today’s group of beloved tech stocks. Everyone except ServiceNow has seen their P/S ratio drop over the next decade.
WDAY PS Ratio data according to YCharts
Lowering valuations does not mean a bad investment
Although valuations were declining, each of the stocks significantly outperformed S&P 500 index since 2013. That is not a guarantee for the future. But it should rest on any notion that just because a stock has a high value, it will lead to the market. Before considering pandemic outperformance, you should know that outperformance is true even if you use 2017, 2018, or 2019 as the end point.
WDAY data by YCharts
The current cohort of stocks
Like the standouts from the 2012 IPO class, some of today’s most popular tech stocks are all growing between 50% and 100% annually. This is a rare company and deserves a premium. But even after their P/S ratios were reduced by half or more, the current batch of stocks are still trading at higher values than the 2012 cohort was at their highest.
| company | Peak P/S Ratio | Current P/S Ratio | Reject |
|---|---|---|---|
| Snowflake | 143 | 42 | 71% |
| CrowdStrike | 67 | 31 | 54% |
| DataDog | 69 | 36 | 48% |
| Cloudflare | 114 | 41 | 64% |
| MongoDB | 47 | 26 | 45% |
Data source: YCharts.
Applying the lessons of the past
That means if history is a guide, values could go farther down even for the best -performing businesses. On the bright side, the growth of businesses will more than offset it. In fact, they could still crush the market in the coming years. Each of our 2012 cohort produced.
That highlights perhaps the most important lesson investors can learn from this review: The price you pay for shares is important, but may not be as much as some believe you. Talented companies usually make good investments even if they are priced at seemingly high valuations.
When the mood on Wall Street darkens, they are usually the first to be punished. But bad mood doesn’t last forever. And for many years, business performance was in control. That’s why investors should focus on business results and not on the stock price. The above group all dropped between 30% and 60% from their highest. Shareholders need to accept that they may fall further. But if businesses continue to perform, they are likely to still make good investments.