Software as a Service stocks is one of the most popular sectors for growth investors. When we talk about Software as a Service, it means a software company that sells its products to customers; usually through a recurring subscription model. So what’s the big deal? SaaS companies are incredibly lucrative as stocks. Over time these recurring subscription revenues add up as the company adds more clients and more products to its portfolio. Remember, the company technically only has to create software once. However, they can sell it to clients for decades. Sure, there have to be upgrades and enhancements. But most of the programming groundwork is laid down with the first iteration of the program.
What Are Software as a Service Stocks?
So Software as a Service stocks is obviously publicly traded companies that sell this software. If you like growth stocks, the SaaS industry is definitely for you! This sector holds some of the fastest-growing companies and therefore, some of the most profitable investments. It’s not all positive for SaaS stocks though. Since these companies are in hyper-growth mode, the stock can often come with higher than normal volatility.
Much of the stock price has the future growth potential baked in already. If the company has a poor quarter or shows signs of slowing down, the share price can take a substantial hit in a short amount of time.
Why Do SaaS Stocks Trade at High Valuations?
The future potential growth is often baked into these stocks. Investors watch for growth rates and CAGRs or Compound Annual Growth Rates to determine the future trajectory. If the company is adding a large number of clients each quarter, then for now we can reasonably expect this to continue into the future. Thus we get some pretty inflated and generous forward-looking multiples.
Software as a Service stocks is a relatively new sector of companies. Yet many of them have grown exponentially faster than companies in other industries. Why do SaaS Stocks trade at such high valuations and exhibit such rapid growth? Let’s take a look!
High Gross Margins: As I mentioned earlier, the company only has to create the software once. From there it can sell it to clients for the next twenty years at very little cost. The product is software. And software is digital. You don’t need warehouses or fulfillment centers to physically store or access the software. Digital products are asset-light and capital-light businesses. This equates to incredibly high gross margins over time which is why so many of these stocks trade at such high forward-looking valuations.
Churn Rate: This is something that isn’t often mentioned when breaking down companies and analyzing stocks. Churn is essentially turnover for clients. SaaS companies often have a negative churn. This means that there are typically more clients becoming customers than there are existing customers leaving. This is a negative churn rate and is indicative of just how essential the software is to clients. Think about enterprise software platforms and how many businesses around the world rely on them. Microsoft (NASDAQ: MSFT) and its Windows operating system probably has one of the lowest churn rates in the world.
Large TAM and Growth Rate
The TAM or Total Addressable Market is obviously dependent on which market your software serves. Windows operating systems serve enterprises around the world. As long as there are offices, Windows will always be in demand. Total Addressable Market is also subjective.
What the companies believe to be the market isn’t always accurate. Since a majority of SaaS companies develop software for computers or smartphones, we can reasonably assume that the total addressable market for any SaaS company is vast. Theoretically, anyone with a computer can be in demand of any software. Keep expectations in check. However, the total addressable market for Software as a Service Stocks companies is generally large.
What Are Some Examples of SaaS Stocks?
Software as a Service stocks has taken the market by storm over the past few years. It’s easy to see why they’re so popular. High growth often leads to high returns. SaaS stocks can be extremely rewarding in the long term if you’re ok with some risk. Without further ado, here are just a few of our favorite SaaS.
Adobe (NASDAQ: ADBE): Talk about a silent beast of a company. Adobe is quietly a $300 billion company and it shows no sign of slowing down. We all know it as a PDF reader but did you know that Adobe has a long list of other software and cloud platforms it offers to clients?
Adobe Creative Cloud is the company’s all-in-one creator app that allows you to pick and choose from different Adobe software to craft your own monthly or annual subscription. Adobe estimates that the Creative Cloud TAM will reach as high as $41 billion in 2023.
It’s one of the main companies at the forefront of the broader digital transformation of the world. Soon, because of companies like Adobe, paperwork will be mostly eliminated and everything will be available through your smartphone.
Twilio (NYSE: TWLO): Twilio is a name you hear often on FinTwit, but do you know what the company does? Twilio builds web service APIs or Application Programming Interfaces. What does Twilio APIs do? They provide communication links between smartphones and businesses.
Have you ever been waiting for an Uber or order takeout from a restaurant? Chances are your smartphone received an SMS or email saying that your order is ready or your Uber is on the way.
Twilio allows businesses to contact customers through text messages, phone calls, and other means on their smartphones. It’s a super simple concept.
However, it’s also been extremely lucrative for both the company and its shareholders. Last quarter, Twilio reported $669 million in revenues, good for a 67% year-over-year growth. It’s numbers like this that explain why SaaS stocks trade for as much as they do!
More Software as a Service Stocks to Consider
Shopify (NYSE: SHOP): One of the darlings of the tech sector, Shopify provides entrepreneurs with the software they need to operate an eCommerce store. Shopify is a $187 billion company now.
If you invested in the stock five years ago, it’s returned 3,444% over that time. Talk about a compounder with out-of-this-world growth. Shopify has global partnerships with massive companies like Facebook, Alibaba, Walmart, and TikTok. The entrepreneur software industry is now a one-horse race because of Shopify.
In 2020, Shopify held an 8.6% share of the U.S. eCommerce market; second only to Amazon at a whopping 39%. Shopify has so many arms now, that nobody should be surprised if the software sales can lead Shopify to be a $1 trillion company one of these days.
DocuSign (NASDAQ: DOCU): Sometimes all you need to do is one thing and do it really well. That’s a bull argument for DocuSign. Which is slowly taking over the eSignature industry. Many investors wrote DocuSign off as a COVID-19 pandemic play.
But the digital transformation of signing documents is here to stay. DocuSign has a whopping 988,000 paying customers and had a 50% year-over-year revenue growth this past year. DocuSign also has an impressive 125% net dollar retention rate. This means that returning customers spend 125% more than they did the first time. The digital signature market is fragmented with Adobe being its largest competitor. DocuSign is only a $57 billion company so the runway is long for more growth in the future.
SAAS Stock Symbol
Crowdstrike (NASDAQ: CRWD): The hottest name in one of the fastest-growing industries. CrowdStrike is emerging as a clear leader in the cybersecurity sector. Its Falcon endpoint threat detection network is cloud-based. They utilize artificial intelligence and machine learning. When a threat hits one of its customers, the platform utilizes the 1/10/60 rule. One minute to detect a threat, ten minutes to analyze it, and sixty minutes to neutralize it. Once a threat is neutralized at one endpoint, all other endpoints in the network gain this data; strengthening the overall ecosystem. Some value the cybersecurity industry to be as much as $350 billion by 2025. Therefore, CrowdStrike is well positioned with an impressive portfolio of existing clients.
Final Verdict on Software as a Service Stocks
Buy them, invest in them, and never sell. Those are the general rules when it comes to software as a service stocks. Especially if you can invest in them in the early stage of growth. The stocks we provided are just a handful of the best SaaS stocks on the market. Ones that didn’t make the cut?
ServiceNow, Zoom, Okta, Zscaler, Cloudflare, Asana, Salesforce.com, Datadog, MongoDB, and Atlassian; just to name a few. As we continue to rely on software and apps to power the future of digital transformation, there will be more companies and more stocks that’ll emerge as powerful investments over the long run. SaaS stocks are expensive and absolutely overvalued. However, focus on the future growth potential rather than its current sales numbers.