The recent downturn in software-as-a-service (SaaS) stocks could represent a significant buying opportunity, according to private equity firm Thoma Bravo, which has established itself as a leader in the SaaS investment space. The firm, which currently owns around 80 software companies, highlighted in a recent presentation that while SaaS stock valuations have declined, the underlying fundamentals are improving. Thoma Bravo forecasts a 20% annual growth rate for SaaS companies over the next few years, significantly outpacing the revenue growth of companies in other sectors.
SaaS companies listed in the S&P 500 are reportedly experiencing revenue growth at three times the rate of their counterparts in other industries, coupled with notably higher gross margins. This divergence between valuation and fundamentals has the firm optimistic about the sector’s future. However, Thoma Bravo cautioned that not all SaaS companies will thrive; some will likely face disruption from advances in artificial intelligence (AI). The firm believes that companies with substantial domain expertise will emerge as leaders in this new environment.
Several notable companies exemplify this potential. ServiceNow (NYSE: NOW) stands out as a leader deeply integrated into its customers’ workflows, particularly in IT departments. Its solutions facilitate management of networks and support tasks while expanding into areas like human resources and customer service through digital processing and workflow automation. ServiceNow has also made strides in AI, introducing innovative platforms such as Now Assist and Control Tower. Despite market challenges, the company maintains a 20% revenue growth rate, with its stock now trading at an appealing forward price-to-sales (P/S) ratio of below seven times and a forward price-to-earnings (P/E) ratio of 25 times.
Salesforce (NYSE: CRM) is another prominent player in the SaaS market, known for its leadership in customer relationship management. The company has successfully leveraged its vast customer data to eliminate departmental silos, enhancing service delivery. Salesforce’s Data 360 offers a sophisticated approach by allowing access to third-party cloud data without requiring data migration. This capability, combined with its acquisition of Informatica, positions Salesforce to excel in the age of AI, where data quality is paramount. The company’s stock is trading at a forward P/S ratio of just 3.7 times and a forward P/E ratio of 14 times, suggesting significant undervaluation despite projected strong double-digit revenue growth.
Workday (NASDAQ: WDAY) also presents an intriguing case, particularly given its substantial data assets in finance and human capital management. Its shares have suffered a significant decline, down approximately 40% year-to-date, placing its valuation at a forward P/S multiple of around three times and a forward P/E ratio of 12 times. Despite these challenges, Workday continues to grow its revenue at a respectable low-teens rate and is actively integrating AI into its offerings, including products focused on recruiting, contract intelligence, and talent optimization. While there are concerns about potential workforce reductions affecting demand for its services, the company is well-positioned for a future that may shift toward consumption-oriented pricing models.
Investors considering whether to buy shares in ServiceNow should note that while the company has strong potential, it was not included in a recent list of top stocks identified by The Motley Fool Stock Advisor. The list has historically highlighted companies that yield impressive returns, such as Netflix and Nvidia, suggesting that while ServiceNow has merit, other investment opportunities may also hold promise.
As the SaaS sector evolves, driven by advancements in AI and changing market dynamics, companies with substantial domain expertise like ServiceNow, Salesforce, and Workday are likely to remain in focus. Their ability to adapt to emerging technologies and leverage data effectively will be critical in navigating the competitive landscape ahead.
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