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So far in 2020, the Dow and the S&P are down 5 to 10 percent, and the Nasdaq is up about 10 percent. The Bessemer Emerging Cloud Index, a good proxy for public cloud software, is up 50 percent in the middle of a global pandemic. For six or seven years, investors in these stocks could get what amounted to venture returns while keeping the ability to trade in and out whenever they wanted.
One explanation would be that the pandemic made digital more important and everyone's forecasts jumped. Comparing company guidance in January with the latest guidance shows Zoom and a couple of outliers with big jumps, while most of the rest is about the same, and a lot of public companies pulled their forecasts. What expanded were multiples. These companies now trade at about 10 to 11 times forward revenue, and the index of more than 100 SaaS companies averages a 35 percent growth rate.
Why do investors value software on revenue?
Many fast-growing software companies report little profit because they spend heavily on growth, so earnings-based measures say little about them. Dividing a company's market value by its expected revenue gives a way to compare them anyway. A higher multiple means investors are paying more for each dollar of expected sales. Companies without profits have no meaningful price-to-earnings ratio.
Why do companies pull their financial forecasts?
Forecasts, called guidance, are voluntary for public companies in the United States. When demand becomes too uncertain to predict, a firm can withdraw guidance rather than risk missing it. Many companies did so in the spring of 2020 as pandemic lockdowns spread. Securities rules do not require a company to publish a revenue forecast.
How do low interest rates lift growth stocks?
A stock's value reflects cash flows expected in the future, discounted back to today at a rate tied to interest rates. Lower rates shrink the discount, which raises the present value of profits expected years from now. Growth companies have more of their value far in the future, so they feel this effect most. The Federal Reserve cut its policy rate to near zero in March 2020.
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