Software companies have a unique business model. They carry a high gross profit margin, which means they can spend significant amounts of money on operating costs like sales and marketing to drive growth, even if it means a loss on the bottom line. Theoretically, they can cut those operating costs once the business achieves scale, which would swing the business into profitability.
Investors supported that strategy for years -- from venture capitalists at the start-up phase, to everyday investors after an initial public offering. But everything changed in 2022 when inflation soared and the U.S. Federal Reserve rapidly increased interest rates.
The cost of capital skyrocketed, and investors pulled away from tech companies that were losing money, fearing they wouldn't be able to attract further cash infusions. Those conditions sent software stocks plunging, and many are still trading significantly below their all-time highs.
Image source: Getty Images.
The tide might be turning
After crashing 33% in 2022, the Nasdaq-100 technology index has bounced back convincingly this year, with a 47% gain so far. Most experts agree the Fed has finished raising interest rates, and CME Group's FedWatch tracker suggests there could be five rate cuts next year.
That changes the calculus for investors when it comes to owning stocks. The lucrative risk-free returns they have earned in cash deposits and U.S. government Treasury bonds this year will slowly erode, which will make growth stocks more attractive once again. Plus, for the companies themselves, it should become easier to raise fresh capital to keep their growth engines running.
As a result, shares of software companies Workiva (WK 1.91%) and Atlassian (TEAM 0.83%) have recently bounced back from their 52-week lows. But they are still trading 37% and 57% below their best-ever levels, respectively. Here's why investors could do very well buying them now.
NYSE: WK
Key Data Points
1. Workiva
Businesses around the world -- especially complex, large organizations -- are increasingly operating online. It helps them reach more customers, streamline their workflows, and even hire global workforces. But it also creates visibility challenges for managers overseeing employees who might not be in the same country, let alone the same office. Not to mention, these employees are working across hundreds of digital applications, so monitoring workflows is a nightmare.
Workiva is solving those problems for almost 6,000 businesses. Its cloud-based platform plugs into popular workplace applications and aggregates their data on one dashboard for maximum visibility. From there, Workiva offers hundreds of templates to help managers report to executives, and even submit regulatory filings to agencies like the Securities and Exchange Commission.
Put simply, Workiva can connect to almost any system of record. Some departments might be using Microsoft Excel, whereas others might be using Salesforce or ServiceNow. It doesn't matter -- Workiva can pull critical information from all of them to manage data in one place.
Workiva is especially popular in tightly regulated industries like banking and financial services, but the company is increasing its addressable opportunity by expanding its product suite. It has invested heavily in building an ESG (environmental, social, and governance) reporting platform to help businesses meet a growing number of regulations. Those new rules require organizations to be more transparent about their impact on the environment and the communities in which they operate.
Higher interest rates have been a drag on Workiva's financial results recently. In the third quarter of 2023 (ended Sept. 30), the company only increased its operating costs by 3% -- yet its net loss at the bottom line soared 89% to $56.2 million. Over $47 million of that was attributable to interest costs, up from just $1.5 million a year ago. This highlights how much harder it is for tech companies to take on (and maintain) debt right now.
Workiva is on track to generate $628 million in revenue in 2023, which will represent a 17% increase from 2022. That's slower than its 21% growth rate last year, which is a consequence of investing less money in operating costs like sales and marketing.
However, Workiva is tackling a $25 billion total addressable market across all of its business segments. Therefore, it has barely scratched the surface of its opportunity. If interest rate pressures ease in the new year as expected, the company could reignite its revenue growth and penetrate its sizable opportunity at a faster pace.
The 37% discount in Workiva stock might present a great buying opportunity for investors who are willing to hold on for the next few years while that scenario develops.
NASDAQ: TEAM
Key Data Points
2. Atlassian
Like Workiva, Atlassian solves critical problems for organizations in an increasingly digital world. Jira and Confluence are two of the company's flagship platforms, and both are designed to drive collaboration in the workplace, no matter where employees might be located. As of the recent fiscal 2024 first quarter (ended Sept. 30), over 265,000 businesses were using Atlassian's software tools.
Jira was created to help technical teams plan, build, and launch software products. Once they are live in the market, the platform becomes a management tool to resolve bugs and continue building new versions.
Confluence is a more mainstream tool. It serves as a virtual workspace for the entire organization, allowing employees of all rankings to share content, centralize information, and coordinate on important decisions.
But Atlassian continues to expand its product portfolio through acquisitions and in-house development. The company recently bought Loom for $975 million, which will integrate with Jira and Confluence, so users can attach video content to their workflows. Therefore, instead of hosting a meeting to discuss a task, staff members can include a detailed video explanation complete with a screen recording to get their message across more effectively.
Atlassian also just launched a new product called Compass, which allows developers to keep track of the complex web of ownership, compliance, and dependencies for software projects. Plus, the company continues to roll out new artificial intelligence (AI)-powered features for all its platforms to help users refine their messaging and speed up workflows.
Like Workiva, Atlassian has delivered sluggish financial results recently. Its Q1 revenue grew by just 21% year over year to $977 million, far slower than the 31% growth rate it generated in the same quarter last year. But more customers are deploying online-based versions of Atlassian's software because it's far more versatile, which drove its cloud revenue to outperform with an increase of 27%.
Atlassian is also carefully watching its spending amid the tough economic climate, increasing its operating costs by just 16% during the quarter. Its bottom-line loss worsened slightly year over year, but at $31.8 million, it's a mere fraction of the company's overall revenue. Minor cost cuts would likely swing it into profitability.
Atlassian's continued investments in new products and services will ensure it's well placed to capture more customers when conditions improve. Based on the 57% drop in its stock from its all-time high, it's currently trading near its cheapest price-to-sales valuation since the company came public in 2015. That presents an enticing long-term opportunity for investors.
