3 software stocks to pick up in the next stock market crash
Some of the biggest winners of the Very Weird Year of 2020 were cloud software stocks. In fact, business was so good that many software unicorns decided to go public amid soaring stock prices. If your product enabled working from home, facilitated better and faster use of data, or secured company infrastructure, your stock has likely skyrocketed.
However, after a mind-boggling 2020, these names might undergo a correction. Many are trading at nosebleed valuations. Meanwhile, recent short-term cuts could cause hedge funds to sell other big winners, including these enterprise software stocks. The vaccine rollout may cause investors to turn to “reopening” stocks in travel, financials and other cyclical stocks at the expense of cloud software.
But while SaaS stocks could face a tough year ahead, all are ushering in a powerful new era of data. So if there is a pullback in the space, long-term investors can get an attractive entry position. The following three cloud leaders are currently on my radar.
JFrog (FROG -4.53%) is one of the top-flight SaaS companies that went public during the busy month of September 2020. JFrog’s tools enable “liquid software” updates, or continuous updates and fixes to applications, rather than the traditional method of building entirely new code every the few months (or more).
Source code must turn into binary code to be deployed, and JFrog’s platform enables the storage, organization, automation, and deployment of these binary code packages. Best of all, it works across all clouds, on-premises data centers, and programming languages.
Last quarter, JFrog software was used by 75% of the Fortune 100 and 27% of the Global 2000. It may seem that JFrog has already penetrated a large part of its market. However, the company’s 136% net expansion rate suggests that existing customers are increasing their use of JFrog over time and moving to more expensive tiers.
Although revenue increased “only” 40% last quarter, this may be due to the fact that the pandemic slowed the sales cycle to new customers. Still, 40% growth is pretty good. JFrog has also shown the ability to increase gross margins and operating margins as it grows, and the company is already generating free cash flow (although it still has GAAP losses due to stock-based compensation).
JFrog expects to end the year with around $150 million in revenue. At the current market cap of $5.7 billion, that seems expensive, at around 38 times sales.
Still, being a cloud-neutral frontrunner in an important niche is a great place to be. This is why JFrog is on my radar in case software stocks pull back in 2021.
Like JFrog, Okta (OKTA -9.41%) is a cloud-neutral pioneer with mission-critical features. Okta’s Identity-as-a-Service software enables an organization’s employees to access critical data and applications, wherever they are. Okta has therefore been extremely useful in the current work-from-home environment and should continue to grow strongly as the workforce becomes more distributed.
In fact, Okta identifies its opportunity in the $30 billion workforce identity market. If the company can grow into customer-facing identity signing, that’s another $25 billion opportunity. Meanwhile, Okta is only forecasting $823 million in revenue for its current fiscal year, so there’s plenty of room to grow.
Last quarter, Okta showed strength across the board. Customers increased by 27% and high-value customers increased by 34%. Net expansion of 123% accelerated from 117% in the prior year quarter, driving revenue growth of 42%. Remaining performance obligations, which take into account future revenues that have not yet been recognized, increased by 53%. Gross margins, operating margins and free cash flow margins have all increased, showing that profitability is in Okta’s future, even as the company is currently posting GAAP losses.
Despite all of these qualities, Okta is currently trading at 42x 12-month sales, or about 40x enterprise value over FY2021 estimates. That’s high. Even if Okta hits its growth target of 35% revenue growth through 2024 and hits its free cash flow margin target of 25%, it would still only earn about $683 million in free cash flow. . That means the stock is currently trading at 49 times its estimated 2024 cash flow. As great as Okta is as a company, that doesn’t give it much leeway. Still, it will surely be at the top of my list if the SaaS industry falls out of favor.
Maybe it was Snowflake (SNOW -7.68%) was arguably the poster child of 2020’s IPO mania. Like the two aforementioned names, Snowflake is a forerunner in cloud data warehousing and management. It offers cloud neutrality that resonates with customers. The founders of Snowflake decided to jump into the cloud early on, ignoring traditional on-premises data management. The results of that first decision were downright impressive.
Snowflake is the fastest growing of any major software company you could find, but it’s also the most expensive. Revenue grew 118% last quarter, but like JFrog, its remaining performance obligations — essentially prepayments for future use — doubled that rate to 240%. Customers increased by 84% and customers spending over $1 million also increased by 110%. Fortune 500 customers increased 56% to 165. Net expansion with existing customers increased 162%. Over the past two years, gross margins have increased by 10 percentage points, from 58% to 68%.
Snowflake’s cloud platform resonates clearly, as it has broken down the barriers and silos that previously separated various forms of data. Companies large and small can transfer everything into Snowflake to discover, manipulate, and run machine learning on its data cloud. Snowflake’s Revolutionary data exchange allows different companies and data providers to securely share data with each other, resulting in even more and better insights. Twenty-three percent of Snowflake customers currently use data sharing features. This should increase in the future.
Despite all this good news, shares of Snowflake are indeed quite expensive, having more than doubled from its IPO price of $120, which itself is up 50% from the IPO price. foreseen. It is also trading at 158 times sales. At this height, it is possible that the company is doing quite well even if the stock stagnates.
Snowflake is currently too rich for my blood, but it’s an impressive company with a promising management team and future. Add it to your watch list in case of a market or tech crash.