Amid the S&P 500’s nearly 5% gain over the past six months, one subsector has done exceptionally well: software-as-a-service (SaaS) stocks, particularly those providing platforms and applications to help businesses. The market seems head over heels for these stocks. Cloud-based customer relationship management company salesforce.com (NYSE:CRM), financial software company Intuit (NASDAQ:INTU), e-commerce platform Shopify (NYSE:SHOP), and payment processor Square (NYSE:SQ) have all soared 30% or more during the last six months alone.
Is the market’s bullishness toward these four companies justified, or has optimism for these SaaS stocks gotten carried away? As it turns out, these companies’ strong performance in their underlying businesses recently makes a good case for their stocks’ massive outperformance.
Here are two things these companies have going for them.
1. Rapid growth
One characteristic all of four of these companies have in common is rapid top-line growth — a trend that is clearly portrayed in each company’s most recently reported quarters.
Salesforce, Intuit, Shopify, and Square saw their revenue surge 25%, 15%, 68%, and 45% year over year in their most recent quarters, respectively. Further highlighting these companies’ momentum, each company increased its outlook for its full-year revenue for its current fiscal year when they announced their most recent quarterly results.
Here are some other notable insights about these four companies’ strong growth trajectories:
- Salesforce, Intuit, and Square all saw their quarterly year-over-year revenue growth accelerate in their most recent quarters.
- Shopify’s merchant solutions revenue, which accounts for more than half of Shopify’s total revenue, jumped 75% year over year — an acceleration from 74% year-over-year growth in the prior quarter.
- Analysts currently forecast Salesforce, Intuit, Shopify, and Square’s revenue to increase 20%, 10%, 37%, and 33% year over year in each company’s next fiscal year, respectively.
2. Impressive scalability
All four of these companies are early in their profitability trajectories. Indeed, both Shopify and Square were only profitable on a non-GAAP basis in their most recently reported quarters. But each of these companies has demonstrated signs of scalability, making strong growth in earnings per share likely in the coming years.
Consider how the following achievements highlight the attractiveness of these companies’ business models.
- Salesforce’s gross profit increased 28% year over year in the company’s most recent quarter, outpacing its 25% growth in revenue during the same period.
- Intuit’s GAAP and non-GAAP earnings per share in its most recent quarter increased 24%, significantly outpacing Intuit’s 15% revenue growth during the same timeframe.
- Shopify’s gross profit increased 71% year over year in its most recent quarter, rising slightly faster than revenue.
- Square’s 47% year-over-year gross profit growth in its most recent quarter also slightly outpaced its revenue growth during the same period.
Buy, sell, or hold?
Despite how quickly each of these companies is growing, there’s a downside to their stocks’ recent rapid gains: Investors have to pay a much higher premium to buy them today than six months ago. Their price-to-sales ratios have appreciated about 20% or more over the last six months, with Square’s rising a whopping 45%. Today, Salesforce, Intuit, Shopify, and Square have P/S ratios of 9.1, 9.2, 21.7, and 10.1, respectively. This compares to an average P/S ratio of 6.8 for stocks in the software application industry.
But these stocks’ pricey valuations shouldn’t eliminate them from your watchlist. If these companies can keep capitalizing on the strong growth opportunities ahead of them, they could be outperformers over the long haul.
We personally recommended each of these stocks in the past, and we still believe they will continue to outperform the market over the long haul. But their sharp share-price appreciation means there’s more inherent risk — and possibly more volatility — for investors who buy today.
For investors willing to hold for five or more years, I’m still calling these stocks buys — but keep any new positions small.
