What happened
Shares of enterprise software disruptors Snowflake (SNOW -1.00%), Datadog (DDOG -2.68%), and MongoDB (MDB -2.02%) plunged by 6.4%, 6.4%, and 6.3%, respectively, on Tuesday.
There wasn't any material news out of these companies specifically, as most companies are in a quiet period ahead of the earnings reports. However, comments from Bill McDermott, CEO of their enterprise SaaS peer, ServiceNow (NOW -1.12%), on CNBC's Mad Money Monday night could be making investors somewhat nervous about the software sector's upcoming reports. Additionally, since these stocks had all enjoyed a three-week rally heading into this week, some traders may be locking in profits ahead of June's Consumer Price Index report, due out Wednesday.
So what
On Monday night's episode of Mad Money, ServiceNow's McDermott actually gave quite a bullish outlook for technology stocks in general, especially those that cater to enterprise customers. That's because technology helps companies become more efficient, please customers, and limit costs in areas such as labor, where their expenses have been growing.
While ServiceNow's automation suite certainly helps companies on those fronts, so do the offerings of these three powerful franchises. Snowflake helps companies collect, analyze, and act on their vast troves of data quickly, helping them gain insights they were unable to before. MongoDB's document-style databases are gaining favor on this front as well, allowing businesses to organize both structured and unstructured data in a more intuitive way. Finally, Datadog's cloud platform helps organizations monitor and track the performance of all of their important business and consumer-facing software applications while also detecting threats.
On the other hand, McDermott also said some business projects that don't offer immediate returns on investment may get delayed this year, and the strong dollar could hurt the revenue figures for tech companies with significant international operations this quarter.
Last quarter, MongoDB got about 40% of its revenues from outside the U.S., Snowflake got about 20% of its revenues from outside the U.S., and Datadog received about 28.4% of its revenue from outside North America, so a strong dollar could tamp down their top-line results this earnings season.
Additionally, investors will be getting new inflation data Wednesday when the Bureau of Labor Statistics releases the June Consumer Price Index. The May CPI report showed higher-than-expected inflation, which prompted the Federal Reserve to hike the federal funds rate by 75 basis points in mid-June. That actually proved to be a positive for these three stocks, as investors began to pivot from inflation fears to recession fears.
Long-term bond yields fell, which helped these three growth stocks move higher. That's because none of them are earning material profits today, but their growth paths suggest they will in the future. When future earnings are discounted by a lower long-term bond yield back to the present, their intrinsic value goes up.
Since the last report and the subsequent Fed interest rate hikes led to such a big bounce for growth stocks, it's possible that the opposite result could be triggered by Wednesday's report. With that prospect in mind, traders may be taking profits on the recent software stock bounces.
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Now what
It's probably a good idea for investors to think skeptically about these three stocks at the moment. That's not because they aren't great companies -- they are. Rather, the concern is their sky-high valuations. Snowflake, Datadog, and MongoDB still trade at 31, 26, and 20 times sales, respectively. Despite each company's market cap having been cut down between 41% and 55% this year already, those valuations don't leave much room for error.
Each of these companies has a bright future, and their shares may be appropriate buys for young, growth-oriented investors who can sit tight through further near-term declines, but it's no surprise to see more conservative traders taking some bets off the table. However, all three belong on any tech investor's watch list, given their high growth rates and leading franchises in their respective niches.
