What happened
Shares of enterprise software companies Twilio (TWLO 2.29%), Snowflake (SNOW 2.17%), and Appian (APPN 4.19%) fell hard again Monday, down 6.3%, 9.3%, and 6.5%, respectively, as of 3:44 p.m. EDT.
There wasn't much in the way of news for any of these three companies today. But one of their cloud-based peers plunged over 25% on news its CEO was stepping down. In addition, long-term bond yields remained high. The longer that remains the case, the more difficult it will be for more high-multiple software stocks without profits to move higher.
So what
On Monday, cloud-based service-center software company Five9 (FIVN 2.87%) plunged over 25%, after CEO Rowan Trollope announced he would be resigning for another role at a pre-IPO tech company. Chairman and former CEO Mike Burkland will be stepping into the role. What's curious is that Five9 also previewed third-quarter earnings results along with the announcement, and those results actually came in ahead of its prior guidance both for revenue and earnings.
It seems kind of strange that the stock, which had already fallen nearly 50% on the year before this announcement, would fall so much. But this is really where the technology sector is right now. Any suspicion of a negative lurking somewhere might cause investors to sell first and ask questions later.
Of these three stocks, Twilio is closest to Five9, as it sells its own call-center software product called Twilio Flex. As is the case in day-to-day trading, problems in one company within a sector can cause a sell-off-by-association with other companies in that same sector. But again, it's a bit strange, since Five9 also announced an earnings beat.
Rising bond yields this year have also soured investors on basically all technology stocks. This goes for both high-growth software stocks that trade at high valuations, as well as more-cyclical stocks like semiconductors. On Monday, more restrictive regulations on semiconductor and semiconductor equipment sales to China were announced, putting a damper on any sort of tech company that might sell advanced products to the country, and souring investors further on the sector.
The 10-year Treasury bond yield also stayed high, up slightly to a 3.89% yield, even as recession fears linger. That yield is more than double what it was to start the year, and has implications for stock valuations, especially growth tech stocks that are unprofitable now and probably won't make material profits for a few years.
That might be what's affecting Snowflake so much today, as it remains perhaps the most expensive stock in the sector, trading over 31 times trailing sales. While it's true Snowflake has been a standout in revenue growth, that high a valuation and continued operating losses make it particularly susceptible whenever there is anxiety about interest rates or a potential economic slowdown. Unfortunately in 2022, we have both, since inflation has soared to a 40-year high coming out of the pandemic.
Now what
The positive news for investors is that this sell-off doesn't appear to have anything to do with these companies' operations, or perhaps even their long-term prospects. Today's declines seem to be either a valuation-based sell-off or just de-risking and tax-loss selling before earnings season.
Unfortunately, even after these large declines, it's really difficult to call these stocks cheap based on their multiples of sales. In the preceding decade of low interest rates, investors seemed fine valuing stocks off revenues and growth. But if we are now in an era of higher interest rates, investors may demand more certainty on profits, dividends, and share repurchases.
The Federal Reserve does intend to get inflation back to 2% over time, which means eventually bond yields should stabilize and likely come down. However, there is a lot of uncertainty regarding if and when we get there. While unprofitable growth stocks could end up being big winners if yields come down fast, that seems unlikely to happen in the near-term.
Investors in these kinds of expensive software names may want to think carefully about their allocation to these types of stocks, and should perhaps rebalance with a healthier mix of cash-generating stocks at lower valuations to go along with them.
