What happened
Shares of high-flying enterprise software-as-a-service (SaaS) stocks Datadog (DDOG 3.58%), HubSpot (HUBS 2.96%), and MongoDB (MDB 7.69%) were falling hard today, down 5.5%, 5.7%, and 4.5%, respectively, as of 3:52 p.m. ET.
There wasn't any material news out of these three companies today. Likely, the market is quite nervous about tomorrow's Federal Reserve meeting and commentary from Chair Jay Powell. If Powell's commentary is more hawkish than anticipated, meaning that investors fear worse inflation and even more aggressive rate hikes in the future, it could hurt valuations of growth stocks, which have most of their profitability well out in the future.
So what
Make no mistake, today's sell-off has nothing to do with the performance of these companies, which have been doing quite well. Datadog has established itself as a go-to solution for application observability, or software that monitors the health and security of a company's important applications. As a cloud-first solution, Datadog looks to benefit from the hyper-growth of cloud software. All of the big three cloud computing infrastructure companies reported solid cloud growth last quarter, which bodes well for Datadog. Datadog grew revenue a whopping 83.7% last quarter.
HubSpot was another darling of the stay-at-home economy, as it provides digital marketing solutions to help small and medium-size businesses reach customers over the web. HubSpot has also grown its product set, from inbound marketing tools to a full-fledged customer relationship management platform that's catching on with enterprises large and small. Revenue grew a strong 46.5% last quarter.
Meanwhile, MongoDB is disrupting the important enterprise database space, with its document format database gaining popularity versus traditional row-and-column relational databases. Last quarter, MongoDB grew revenue 55.8%, with its cloud-based Atlas database-as-a-service offering growing fast.
These are all really impressive numbers and bode well for each company's long-term competitive position. Still, none of these companies generates profits today, and they trade at high price-to-sales multiples, with Datadog at 36, HubSpot at 13.5, and MongoDB at 26 times sales.
There was once a time when 10 times sales was considered expensive, but the recent era of all-star cloud software companies and low interest rates changed that. However, valuations are now de-rating back toward something closer to the prior era, though how much remains to be seen. If the Fed puts the economy on a path to materially higher interest rates, it could further hurt the valuations of these companies, even if their operating metrics remain good.
In a "good news is bad news" data point today, data was released showing a record high number of job openings in the U.S. While available jobs are a good thing for the economy, the labor shortage could spur more wage hikes, which would not be good when taken to the extreme. That's because if wages rise enough, prices of goods and services could follow, which could spur more wage increases to keep up with the cost of living, in what is known as the dreaded wage-price spiral.
That recent data point could spur the Fed to be more aggressive. So even though these stocks are down materially from their highs, it could be a challenging environment for them in the near term.
Image source: Getty Images.
Now what
Given the uncertainty about interest rates, it is hard to recommend buying or adding to these three names at these prices. I own MongoDB, but that was bought at significantly lower prices. These high-quality stocks seem like holds today, and potential sells if one needs near-term cash, as it may be difficult for them to overcome the valuation contraction going on.
Still, these three stocks seem like winners over the long term, so each belongs on your shopping list, should their prices fall further. I'd also be eager to see if these companies attempt to generate actual profits this year, instead of plowing very possible dollar back into growth. It will be interesting to see how even the top names in the SaaS space adjust to this new higher rate environment.
