What happened
Shares of big data enterprise software companies Snowflake (SNOW -1.99%), MongoDB (MDB -2.41%) and Datadog (DDOG -3.94%) plunged today, each falling by the high single digits before recovering slightly to respective declines of 4.6%, 6.3%, and 8.2% as of 11:41 a.m. ET.
This doesn't have anything to do with these companies' operational performance. In fact, these three companies reported strong growth and outlooks during the recent earnings season and are generally considered best of breed in the up-and-coming software-as-a-service sector for big data applications.
However, this morning's Consumer Price Index (CPI) inflation report came in hotter than expected, which decimated virtually all technology stocks.
So what
This morning, the Bureau of Labor Statistics released the August CPI report. While many were hoping to see a rapid decline in inflation, instead they got the opposite. While the year-over-year inflation print of 8.3% marked a deceleration from the 8.5% print in July, it was higher than expected. Perhaps more disturbing were the month-over-month numbers. Overall, inflation rose 0.1% from July to August, but that was higher than expectations for a 0.1% decline. Core inflation, which strips out volatile food and energy prices, rose 0.6% month over month, much higher than the 0.3% that was expected. Both accelerated over the July numbers.
The report unfortunately means that some parts of the inflationary picture could be "stickier" than assumed. That also means the Federal Reserve is likely to continue hiking interest rates aggressively. In response to this morning's report, the 10-year Treasury Bond yield rose to 3.43%, within shouting distance of the June highs.
High-growth stocks like Snowflake, Datadog, and MongoDB are highly sensitive to rising interest rates in two ways. First, they tend to be expensive stocks. Snowflake trades at 35 times sales, Datadog at 23 times sales, and MongoDB at 16 times sales. Those are all quite expensive by historical measures and assume lots of growth -- and eventually profits -- well into the future.
When long-term interest rates go up on the assumption of higher inflation, equity investors tend to use a higher discount rate on companies' future profits to judge intrinsic value. That means the further out in the future those profits are, the less they are worth today, all else being equal.
Second, the purpose of higher interest rates is, obviously, to cool down the economy. However, interest rates are a pretty blunt tool, and it's possible the Federal Reserve could tip the economy into a recession. Last quarter, Snowflake grew revenue 83%, Datadog grew 74%, and MongoDB grew 57%.
If the economy slows meaningfully, it may be difficult for these companies to keep up high growth rates, even though their data-based offerings are seeing increasing adoption. Investors tend to extrapolate current performance, so if a hyper-growth stock slows down meaningfully, it usually means bad things for the share price.
Now what
It is interesting that Snowflake is the most expensive of these stocks on a price-to-sales basis, but it's down relatively less than the others. That may be because Snowflake operates on a consumption model, whereby customers pay more as they use more. That's in contrast to most other software-as-a-service models, which operate on a subscription basis.
If the economy is currently running hotter than expected, businesses may use more of Snowflake's cloud-based data lake than normal, which could help increase Snowflake's revenue. However, a fixed subscription under a one-, two-, or three-year contract can't increase in price until the contract ends. If the SaaS company is experiencing inflationary pressures from, say, labor, it may see margin compression.
However, with such a large surprise in inflation, most stocks in the same sector will be moving in the same direction by similar magnitudes.
But there is a silver lining for long-term investors. When stocks have a big move down due to macroeconomic factors, investors should think about buying or adding to their favorite high-quality stocks at a discount -- that is, as long as the stocks are reasonably priced and highly likely to make it through a potential economic downturn.
