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Shares of popular software stocks Palantir (PLTR -2.77%), Snowflake (SNOW -4.35%), and Datadog (DDOG -5.47%) plunged today, falling 4.4%, 5.6%, and 6.2%, respectively, as of 2:23 p.m. ET.
While the tech-heavy Nasdaq was also down a big 3.3% on the day at that time, these high-growth software-as-a-service (SaaS) stocks fell by even more. That has been a constant theme through 2022, as the Federal Reserve’s unprecedented interest rate-hiking cycle has decimated expensive, unprofitable growth stocks — even if they are posting solid top-line growth.
Thursday saw the release of some GDP data that pointed to continued rate increases, dashing hopes of investors who had thought the inflation monster had been slayed. These three names were just a few of the many victims in the tech space.
In another episode of “good news is bad news” in this market, today the government’s Bureau of Economic Analysis released its third revision of third-quarter U.S. gross domestic product. In that revision, the BEA revised third-quarter GDP up to 3.2% growth, up from its prior estimate of 2.9%.
Current revisions incorporate more data, meaning the economy was stronger than expected last summer. In addition, the past week’s jobless claims rose slightly to 216,000, up 2,000 from last week, which is still pointing to a very tight labor market.
In a normal world, stronger GDP and plentiful jobs would be a good thing, but not when the Federal Reserve is trying to tame inflation, especially wage inflation. The strong economic and jobs numbers therefore indicate the Fed may have to go further in hiking the federal funds rate, whereas many had thought that the better-than-expected inflation numbers from October and November would engender a “pause” from Fed officials.
Rising interest rates are especially bad for high-growth software stocks that will see the bulk of their earnings far out into the future, since higher rates discount the present value of future earnings. The farther away those profits are, the less they are worth in today’s terms, when interest rates are high. This is why these high-quality growth names move so much on any given day, depending on economic data and speeches by Fed officials.
To illustrate this point, yesterday, Palantir rose with the market, despite Wolfe Research analyst Alex Zukin downgrading the stock to “underperform” and putting a $4.50 price target on this $6.20 stock. Zukin noted the expensive, time-consuming integration needed to run Palantir’s software as a headwind, while also noting the “lumpiness” of large government contracts as limiting visibility.
Yet today, when inflation and rate fears kicked in, Palantir sold off hard, despite Bank of America analysts defending the stock, calling the sell-off “overdone” and putting a $14 price target on the beaten-down software name. Bank of America actually likes Palantir’s strong, entrenched standing with defense contractors, even if those revenues come in unevenly, while also noting Palantir’s strong cash position, which in and of itself amounts to about $1 per share.
It may be frustrating that these stocks are so vulnerable to the minutiae of macroeconomic data, interest rates, and what any random Federal Reserve governor might say on any given day; however, this is the market in 2022.
Long-term investors should look at the bright side: This rate-driven market sell-off may be opening up long-term buying opportunities. For instance, Snowflake is nearly back down to its IPO price of $120, which is the price at which Warren Buffett’s Berkshire Hathaway bought shares on the IPO.
Along with Snowflake, Datadog is also seen as a leader and winner in the software observability space. Datadog is also operating close to GAAP profitability while maintaining high growth rates.
Still, I wouldn’t classify either stock as “cheap,” as Datadog and Snowflake still trade at very high multiples of sales. Yet investors should at least be making a list of the best-in-class growth stocks that are performing well but which have nonetheless been decimated by this rate-driven market.
Interested investors should try to figure out the intrinsic value of these stocks based on a discounted cash flow model. If these names fall far enough and reach your price target, you should be ready to pounce in the new year, as we seem to be getting toward the latter stages of this rate-hiking cycle.
Bank of America is an advertising partner of The Ascent, a Motley Fool company. Billy Duberstein has positions in Bank of America and Berkshire Hathaway. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends Bank of America, Berkshire Hathaway, Datadog, Palantir Technologies, and Snowflake. The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway, short January 2023 $200 puts on Berkshire Hathaway, and short January 2023 $265 calls on Berkshire Hathaway. The Motley Fool has a disclosure policy.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
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