What happened
Shares of cloud software favorites Zscaler (ZS -3.41%), Snowflake (SNOW -1.42%), and Datadog (DDOG -2.77%) were surging this week, up 29%, 10.3%, and 13.2%, respectively, through Thursday trading, according to data provided by S&P Global Market Intelligence.
It was a good week for high-growth cloud software stocks on several fronts. Zscaler made a positive pre-announcement, and a Wall Street analyst issued a note suggesting the optimization in cloud software spending might be coming to an end.
Softer-than-expected inflation readings for April also helped, as these growth stocks are highly sensitive to inflation and interest rates.
So what
The week started off well Monday, when Zscaler decided to pre-announce fiscal third-quarter results. Management disclosed it now expects a big beat relative to analyst estimates, with third-quarter revenue projected to be between $415 million and $419 million, much higher than its prior guidance of $396 million to $398 million and consensus expectations of $400.5 million. In addition, non-GAAP (adjusted) operating income is now projected at $60 million to $64 million, versus prior guidance of $55 million to $56 million.
Chairman and CEO Jay Chaudhry said: "We had a strong finish to the quarter as the high ROI of adopting the Zscaler Zero Trust Exchange platform continues to resonate with customers and prospects in this challenging macro environment. ... Our customer engagements are strong, and our platform continues to expand with innovations that solve our customers' real time IT challenges."
Also on Monday, Stifel analyst Brad Reback upgraded Snowflake from hold to buy, citing the recent earnings commentary from Datadog and other cloud software companies that the multiquarter slowdown may be ending. Reback now sees Snowflake's growth stabilizing in the high-30% range, as cloud optimizations may be nearing their end. Enterprises have used the high-inflation, high-rate environment to look for ways to optimize their cloud spend and consolidate vendors. There is, however, only so much cutting a company can do, as the cloud transition continues over multiple years. Furthermore, Reback sees Snowflake getting a boost from the generative AI market as a leading cloud data lake provider.
The positive Zscaler announcement and Snowflake upgrade dovetails with last week's Datadog earnings announcement, which also beat estimates for revenue along with raised full-year guidance. Datadog also operates at the nexus of data and security with its cloud observability suite.
In addition to the positive industry-specific commentary, cloud stocks were also likely helped by this week's inflation data release for the month of April. On Wednesday, the Consumer Price Index (CPI) came in at 0.4% month over month and 4.9% year over year, slightly lower than expectations of 5%. And on Thursday, the Producer Price Index (PPI), which measures wholesale and input prices, grew just 0.2% versus 0.3%, and 2.3% year over year, which was the lowest reading since January 2021.
Declining inflation numbers should mean that eventually interest rates will come down, which should help growth stocks that have the bulk of their profits well out into the future.
ZS Percent Off All-Time High data by YCharts
Now what
Despite this week's bounce, each of these three cloud stocks are still far, far below their highs from late 2021, which was arguably a fairly large bubble. Moreover, Zscaler and Datadog still trade at a mid-teens multiple of sales, and Snowflake trades at a mid-20s multiple of sales. Those are still very expensive valuations, implying robust future growth and high future margins.
However, emerging cloud software leaders such as these three do have that capability, as this week's positive news showed.
Still, in order for these stocks to regain their highs, they will likely have to continue executing impressively for multiple years, and interest rates will likely need to fall back to pre-pandemic levels as well.
