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3 Software Stocks to Pick Up in the Next Market Crash

By Billy Duberstein - Feb 2, 2021 at 6:42AM

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Software stocks could be in for a nasty correction this year. Here are three to keep on your watchlist if that happens.

Some of the biggest winners from the very odd year of 2020 were cloud software stocks. In fact, business was so good that many software unicorns decided to go public amid surging stock prices. If your product enabled work-from-home, facilitated better and faster data use, or secured enterprise infrastructure, your stock likely rocketed higher.

However, after a stunning 2020, these names could be in for a correction. Many trade at nosebleed valuations. Meanwhile, recent short squeezes may cause hedge funds to sell other big winners, including these enterprise software stocks. The rollout of vaccines may cause investors to gravitate toward "reopening" stocks in travel, financials, and other cyclical stocks at the expense of cloud software. 

But while SaaS stocks may face a challenging year ahead, all are ushering in a powerful new data era. So if there's a pullback in the space, long-term investors may get an attractive entry position. The following three cloud leaders are currently on my radar.

Two software engineers fist-pump.

Image source: Getty Images.


JFrog (FROG -0.11%) is one of the high-flying SaaS companies that went public in the busy month of September 2020. JFrog's tools enable "liquid software" updates, or continuous updates and patching of applications, rather than the traditional method of constructing an entirely new code every few months (or longer).

Source code must transform into binary code in order to be deployed, and JFrog's platform allows for the storage, organization, automation, and deployment of these binary code packages. Even better, it works across all clouds, on-premises data centers, and programming languages.

As of last quarter, JFrog software was used by 75% of the Fortune 100 and 27% of the Global 2000. That may seem like JFrog has already penetrated a lot of its market. However, the company's 136% net expansion rate suggests existing customers increase their JFrog usage over time and upgrade to higher-priced tiers.

Though revenue grew "only" 40% last quarter, this may have been due to the pandemic slowing the sales cycle to new customers. Still, 40% growth is pretty good. JFrog has also shown the ability to expand gross margins and operating margins as it grows, and the company is already generating free cash flow (though it still has GAAP losses due to stock-based compensation).

JFrog anticipates it will end the year with about $150 million in revenue. At the current $5.7 billion market cap, it seems expensive, at around 38 times sales.

Nevertheless, being a cloud-neutral first-mover in an important niche is a great place to be. That's why JFrog is on my radar in case software stocks pull back in 2021.

Two sets of hands on laptops typing code overlayed  with animation.

Enterprise software stocks have been huge COVID-19 winners. Image source: Getty Images.


Like JFrog, Okta (OKTA -6.93%) is a cloud-neutral first-mover with mission-critical functionality. Okta's identity-as-a-service software allows employees of an organization to access critical data and applications, no matter where they are. Okta has therefore been tremendously helpful in the current work-from-home environment, and should remain a strong grower as workforces become more distributed.

In fact, Okta identifies its workforce identity market opportunity at $30 billion. If the company can expand into customer-facing identity sign-on, that's another $25 billion opportunity. Meanwhile, Okta projects only $823 million in revenue for its current fiscal year, so there's a lot of room to grow.

Last quarter, Okta showed strength across the board. Customers grew 27%, and high-value customers grew 34%. Net expansion of 123% accelerated from 117% in the year-ago quarter, leading to 42% revenue growth. Remaining performance obligations, which take into account future revenue yet to be recognized, grew an even higher 53%. Gross margins, operating margins, and free cash flow margins all expanded, showing profitability is in Okta's future, even if the company currently posts GAAP losses.

Despite all this goodness, Okta currently trades at 42 times trailing 12-month sales, or about 40 times its enterprise value to FY 2021 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 make only about $683 million in free cash flow. That means the stock currently trades at 49 times its 2024 estimated cash flow. As great a company as Okta is, that doesn't give it a whole lot of margin of safety. Still, it will surely be at the top of my list should the SaaS sector fall out of favor.

Abstract of data  flying through a blue and black cyberspace.

The data revolution is real, but stock prices are high. Image source: Getty Images.


Perhaps  was Snowflake (SNOW -5.06%) was arguably the poster child for the 2020 IPO mania. Like the two aforementioned names, Snowflake is a first-mover in cloud-based data warehousing and data management. It offers a cloud neutrality that's resonating with customers. Snowflake's founders decided to go all-in on the cloud early, ignoring traditional on-premises data management. The results of that early decision have been downright impressive. 

Snowflake is growing the fastest of any large software company that you might find, but it's also the most expensive. Revenue grew a stunning 118% last quarter, but like JFrog, its remaining performance obligations -- essentially pre-payments toward future usage -- doubled that rate at 240%. Customers grew 84%, and customers who spend over $1 million grew 110% as well. Fortune 500 customers grew 56% to 165. Net expansion with existing customers grew a ridiculous 162%. Over the past two years, gross margins have expanded 10 percentage points from 58% to 68%.

Snowflake's cloud platform is clearly resonating, as it's broken down the barriers and silos that previously separated various forms of data. Companies large and small can dump everything into Snowflake to discover, manipulate, and run machine learning on its data cloud. Snowflake's revolutionary data exchange allows different enterprises and data providers to safely and securely share data with each other, leading to even more and better insights.  Twenty-three percent of Snowflake's customers currently use data sharing capabilities. That's likely to increase going forward.

Despite all this great news, Snowflake's stock is quite pricey indeed, having more than doubled over its IPO price of $120, which itself was raised 50% from the expected IPO price. It also trades at a lofty 158 times sales. At that height, it's possible for the business to do quite well even as 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 watchlist in the event of a market or tech sector meltdown.

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Stocks Mentioned

Snowflake Inc. Stock Quote
Snowflake Inc.
$150.35 (-5.06%) $-8.01
Okta Stock Quote
$90.93 (-6.93%) $-6.77
JFrog Ltd. Stock Quote
JFrog Ltd.
$18.25 (-0.11%) $0.02

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