What happened
Shares of big data software companies Palantir (PLTR 3.19%), Datadog (DDOG 3.58%), and C3.ai (AI 3.52%) all fell hard today, down 6.8%, 4.5%, and 8.9% as of 1 p.m. ET.
There wasn't any company-specific news today from any of these three companies. Rather, they fell as part of a marketwide sell-off in high-growth stocks, likely due to rising long-term bond yields.
So what
Palantir, Datadog, and C3.ai each operate in different corners of the artificial intelligence (AI), machine learning, and big data processing market. Even though many think we are in for an economic downturn, commentary from leading cloud companies thus far has pointed to resilient strength in these big data tools. That's because AI software applications help make businesses more efficient and competitive, so companies are likely loath to cut back on investments in their digital transformation even if the economy slows.
Earlier this month, Datadog reported sizzling 74% revenue growth, as its cloud-based software observability and IT monitoring tools have been gaining favor with companies large and small. While Palantir disappointed in its earnings release, that entirely came from a slowdown in large government contracts; meanwhile, its commercial business recorded much better 46% growth, with enterprise customers more than tripling year over year. C3.ai was the most worrisome of this bunch, as it recorded "only" 38% growth last quarter, but with subscription growth coming in at a lower 31%. Still, that's pretty solid growth for any company in a slowing economy.
The problem, however, is that none of these companies make material profits, and their valuations, while having compressed relative to the go-go era of 2020-2021, are still high on an absolute basis. That makes each company highly susceptible to changes in long-term interest rates and inflation, and it's why each is selling off today.
As a reminder, high-growth but no- or low-profit stocks have the bulk of their profits well out into the future. The further out their earnings, the more those earnings are discounted by higher interest rates. The higher the long-term discount rate, the lower the value of those future profits.
Today, the 10-year Treasury bond yield rose 10 basis points to 2.99% in early morning trading, reaching the highest yield in a month.That means investors may be thinking inflationary pressures aren't receding as fast as thought. Unsurprisingly, virtually all high-growth stocks are selling off hard.
Yesterday afternoon, U.S. Federal Reserve official James Bullard gave an interview and signaled he was in favor of another 75-basis-point rate hike at the upcoming September meeting. That likely surprised some market participants, which interpreted Chair Jay Powell's comments at the late July Fed meeting as more dovish or neutral. Even the minutes from that meeting showed most Fed officials favored decelerating the pace of rate hikes to a 50-basis-point hike at the September meeting.
Bullard's comments seem to indicate that the Fed doesn't believe we are out of the woods in terms of slaying inflation yet. That's despite inflation figures in July showing their first annualized deceleration this year. Basically, Bullard is saying that one month does not make a trend, and inflation is still unacceptably high; therefore, more financial tightening is likely necessary.
The more hawkish tone comes just as growth stocks have rallied fairly hard off of their June lows; therefore, it's no surprise that after this run, largely based on hopes of a Fed pivot, there is some giveback today.
Now what
These three companies are very exciting, as evidenced by their high growth rates and cutting-edge technology. However, lots of excitement usually leads to a high stock price, and none of these companies look particularly cheap, even after today's rout. Palantir and C3.ai continue to log considerable operating losses according to generally accepted accounting principles (GAAP), when factoring in their stock-based compensation, and they still trade at price-to-sales ratios in the high single digits.
Datadog is a much healthier company and is currently operating at about break-even; however, its stock trades at a whopping 25 times sales. Therefore, even though the business may be doing well, rising interest rates may cap how much the stock can go up in the near term. Nevertheless, its near profitability should make it less susceptible to tightening financial conditions than peers that are still generating large losses.
