Nearly every software stock has gotten crushed over the past year, as slowing enterprise demand and recessionary fears eroded valuations in the high-priced sector.

Earlier this month, it was GitLab's (GTLB 6.17%) turn. Shares of the DevOps platform dove 24% on March 14, after the company issued disappointing guidance in its fourth-quarter earnings report.

While the numbers for the fourth quarter were solid, with revenue up 58% to $122.9 million, management expects a sharp deceleration in growth in fiscal 2024, the current year, forecasting revenue of $529 million to $533 million, or an increase of just 25% at the midpoint.

GitLab is beginning to see the same headwinds that much of the software sector is already experiencing. Sales cycles are getting longer as customers are being more cautious about increasing their spending. Tech layoffs also meant that some companies need fewer seat licenses or that headcount growth slowed at some of its customers. 

Wall Street took the news hard, as the stock came into the earnings report trading at a premium valuation. Even after the sell-off, GitLab is valued at a price-to-sales ratio of 13 -- and the company is unprofitable.

A programmer working on multiple monitors.

Image source: Getty Images.

The silver lining

Much like its peers in the tech sector, GitLab is adapting to changing investor expectations and sharpening its focus on profitability.  

The company is aiming to be free cash flow-neutral by fiscal 2025, or next year, and it's taking some important steps to help achieve that goal.

It's raising prices on its midrange premium tier on April 3, from $19 to $29 per user per month, though that move is expected to have a greater impact on the bottom line next year, as there will be a grace period for existing customers. It's the company's first price increase in more than five years, and management believes it's warranted, as it's added more than 400 new features in that time, among other improvements.

The company also began applying limits to its software-as-a-service free tier for the first time, limiting organizations to five users. GitLab believes this move will encourage customers to convert to one of its paid tiers more quickly, and it also said in February it would lay off 130 employees, reducing its workforce by 7%, a reflection of the changing demand environment.

Those changes are factored into the company's guidance, and it expects its loss to narrow in fiscal 2024, forecasting an adjusted operating loss of $59 million to $64 million, compared with $87.1 million. 

Is GitLab a buy?

2023 is shaping up to be a challenging year for GitLab and the rest of the software sector. Interest rates are still moving higher, meaning valuations should continue to compress, and uncertainty about the economy spiked following the collapse of Silicon Valley Bank and Signature Bank, both of which were known for serving the tech community.

However, the fundamental investing thesis behind GitLab is still intact. The company has little direct competition outside of Microsoft's GitHub, and GitLab's CFO Brian Robins has said the company doesn't face competition in half of its pitches.

The product also delivers strong time-to-value, with an estimated payback period on its highest tier, GitLab Ultimate, of six months. Forrester Research has estimated that GitLab customers can earn as much as a 427% return on investment.

Given that positioning, a trend away from point solutions to single platforms like GitLab, and an estimated addressable market near $40 billion, the company still looks poised for long-term success.

However, investors will have to be patient over the next year, as the stock is unlikely to rebound until the economy is on more solid ground.