Amid a rally in tech stocks, investors have again turned their attention to the software industry. This business has often driven massive gains for investors, as the cloud and applications driven by artificial intelligence (AI) have attracted more interest.
The question for investors is which software-as-a-service (SaaS) stocks will deliver market-beating returns. While no analyst can predict the future, investors could earn considerable gains in DigitalOcean (DOCN 3.30%), SoFi Technologies (SOFI 3.69%), and Twilio (TWLO 1.47%) as market conditions improve.
DigitalOcean
DigitalOcean is a cloud infrastructure provider targeting small and medium-sized businesses. As a company with a $4 billion market cap, it does not look like a competitive threat to the trillion-dollar tech giants that dominate the cloud business.
But despite the size difference, Amazon and Microsoft may struggle to compete with DigitalOcean in its niche. For one, DigitalOcean sells its service a la carte. This way, small and medium-sized businesses only have to buy the specific services they need.
More importantly, DigitalOcean has built a community among its customers, enabling lone IT professionals to reach out to the community when they need to resolve an issue. And since it takes more than money to build such a community, it is unlikely its competitors would attempt a similar approach.
Furthermore, revenue growth has resumed, rising 30% yearly in the first quarter of 2023. And even though the stock has risen 80% since New Year's Day, its price-to-sales (P/S) ratio of 7 is below historic levels. This implies that it could continue to rally despite the recent increases.
SoFi Technologies
Most investors who know SoFi see it as a fintech-oriented bank. Indeed, the rapidly rising bank deposits and the resumption of student loan payments should help the stock.
However, in other respects, it is as much a SaaS company as it is a financial institution. It acquired products that support its software capabilities, buying Galileo in 2020 and Technisys in 2022.
These moves have made SoFi the "Amazon Web Services of fintech," as SoFi describes it. Its software offers end-to-end functionality that supports checking, savings, credit cards, mortgages (thanks to the recent purchase of Wyndham Capital Mortgage), and other financial products and functions. This gives SoFi a competitive advantage over banks that rely on third-party software companies to provide such services.
In Q1, its revenue grew by 43% year over year, and that growth occurred amid a largely inactive student loan business. Moreover, the stock seems to have sustained a rally for the first time in years. SoFi has risen nearly 110% year to date, and it sells for just over 5 times sales. Considering the massive revenue growth and the coming revival of its student loan business, that is a low enough valuation to keep the rally continuing.
Twilio
Twilio has stood out as a communications platform as a service (CPaaS), providing app-driven phone, video, text, and email communications. In essence, Twilio supports Uber Technologies, DoorDash, and other app-driven enterprises, making these businesses possible.
Indeed, other companies could compete for this business. However, Twilio was a first mover, and the disruption involved in switching makes it less likely for customers to leave. It has also expanded its ecosystem by offering products such as Twilio Flex, a built-in contact center that saves developers from having to replicate such software in-house.
Additionally, it has applied AI to power its chatbot and analysis of data to deliver customer insights. And since it has collected significant amounts of data, it has more power to leverage its AI capabilities.
Admittedly, AI breathed new life into the stock as its recent financials did not excite investors. Revenue in Q1 grew by 15%, and the company gave a second-quarter outlook for only 4% to 5% growth. On that news, Twilio plummeted before AI-based excitement led investors back into the stock. Overall, Twilio is up 36% since the beginning of the year, and considering a historically low 3 P/S ratio, its discounted valuation may induce more investors to buy this stock.
