It has been a rocky nine months for software stocks. After soaring 47.6% in 2013, the S&P Software and Services Select Industry Index1 was down 4.85% year-to-date as of September 30, 2014, and down 9.1% since its peak on March 5, 2014. In contrast, the S&P 500 Index was up 8% year-to-date as of September 30, outpacing software by roughly 10%.
U.S. equity markets experienced a sudden reversal in sentiment in late March and early April, sparked by concerns over interest rates and geopolitical unrest. Investors swiftly rotated away from high growth, smaller cap stocks into larger cap “value” stocks in a “flight to safety.” The impact was particularly acute in stocks that had been strong performers, as investors took profits and redeployed their assets elsewhere. Software-as-a service (SaaS) stocks, which had enjoyed an extraordinary runup in 2013, bore the brunt of this reversal in sentiment. Many had been trading at high valuations under non-traditional valuation metrics, in which multiples were being based on revenue instead of earnings, given the large addressable markets of these companies and the significant reinvestments they were making into their businesses. With high growth suddenly out of favor, investors turned to more traditional EBITDA, EPS and cash flow-based metrics and found valuations stretched given minimal near-term expectations of profitability. Continue Reading »