What happened
Shares of enterprise software stocks Atlassian (TEAM -1.61%), Snowflake (SNOW -1.17%), and HubSpot (HUBS -2.24%) all rallied this week, with Atlassian appreciating 20.8%, Snowflake up 14.6%, and HubSpot up 12.7% through Thursday trading, according to S&P Global Market Intelligence.
This week, software stocks had a nice bounce as market participants digested incoming economic and inflation data. In addition, all three stocks garnered positive mentions from Wall Street analysts, even though some lowered their target prices to account for the slowing environment. There was a particularly interesting note on Atlassian flexing its pricing power this week, perhaps explaining its outsized gains relative to the others.
So what
Virtually all growth stocks did very well this week, as incoming economic data showed falling inflation combined with still-solid job growth. Last Friday, the Bureau of Labor Statistics released the December employment report, showing that 223,000 more jobs were added in December. Yet, while the Federal Reserve has been concerned about the tight labor market putting upward pressure on wages, wages only showed 0.3% month-over-month growth -- a good deceleration from the numbers over the prior year.
In addition, the Institute for Supply Management released its Services Purchasing Managers Index (PMI) last Friday, Jan. 6. That figure came in at 49.6, which was much lower than in prior months and the lowest since May of 2020. For reference, a reading below 50 actually signals a contraction.
While a weak reading may be worrisome in a different economic environment, the Federal Reserve has been trying to slow the red-hot services sector, which is where the bulk of current inflation is coming from. Therefore, a softer Services PMI is actually a welcome sight.
Flash-forward to yesterday, and the Consumer Price Index (CPI) for December actually showed deflation, with headline CPI falling 0.1% month over month. Core CPI, which strips out volatile food and energy prices, rose 0.3%, in line with expectations. When taken with October's and November's soft readings, the three-month trend shows inflation is clearly falling -- even with overall net job gains in the economy.
As rising inflation caused a massive sell-off in unprofitable growth stocks last year, falling inflation should do the opposite. This is because, in a high-inflation environment, the value of profits far in the future diminishes. Since each of these software names displays high revenue growth but no current profits, they are some of the biggest beneficiaries of falling inflation and interest rates, which boosts the value of profits far out in the future.
On top of the more favorable economic news, each of these stocks garnered positive analyst commentary this week. On Monday, Piper Sandler analyst Brent Bracelin released an update to several cloud software-as-a-service (SaaS) names, including HubSpot and Snowflake. Bracelin reiterated his "Overweight" rating on HubSpot, although he did lower his price target on shares from $400 to $350. Bracelin's lowered target price is attributed to a broader cloud slowdown and recessionary forces, not HubSpot's competitiveness. Still, given that HubSpot only trades around $300, Bracelin thinks this slowdown is already factored into shares.
Bracelin essentially made the same call on Snowflake, which he also covers, maintaining his Overweight rating while lowering his price target from $200 to $194. Snowflake actually saw a fair amount of analyst activity this week. Barclays analyst Raimo Lenschow also lowered his price target on Snowflake from $180 to $169. Lenschow believes the SaaS industry is in for a rough first half of the year but sees "hope" for the second half.
Citi analyst Tyler Radke also included Snowflake as one of his favorite software stocks for 2023, given its "good sales efficiency with large market opportunities that don't require evangelical sales motions." In lay terms, that seems to mean he favors competitively advantaged, in-demand software products that do a good job of selling themselves and don't need heroic salespeople to sell them in a difficult macro environment.
Finally, Atlassian received perhaps the most intriguing upgrade this week, with Mizuho analyst Gregg Moskowitz naming it a top pick for 2023 while giving the stock a $255 price target -- significantly above today's price of $146. Moskowitz noted that despite the macroeconomic slowdown, Atlassian just decided to raise its prices on renewals, which Moskowitz believes amounts to a "high-teens" percentage increase. It's a bold move for Atlassian to raise prices even as its customers are growing cautious and shows management's confidence in the mission-critical nature of its technology.
Now what
Even though the high-inflation environment may be abating, investors shouldn't expect these stocks to immediately fly back to 2021 levels. Many high-quality software names like these three got way ahead of themselves in terms of valuation. However, these are top-notch products and management teams, as seen in the analyst community's confidence in them this week. Moreover, their shares are still 65%-73% off their 2021 highs, even after this week's move.
Still, it appears investors will be taking a closer, more skeptical look at valuation going forward, even if interest rates stabilize. Interested investors looking for a bottom should attempt to estimate an intrinsic value based on a discounted cash flow model for each name and not just buy into revenue momentum or positive macroeconomic news. Still, all three stocks should be on any growth investor's radar, given their high quality and discounted shares.
