The Software Investing Crapshoot

Plus, discussions on Lululemon and Roaring Kitty on this week's live podcast recording

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On this week’s Power Hour, Ryan came up with a list of 10 software stocks trading at 52-week lows:

• Snowflake

• Atlassian

• Veeva Systems

• MongoDB

• Paycom

• Paylocity

• Dayforce

• Dropbox

• Workiva

• EPAM Systems

We perused through each stock on Finchat.io to see what the financials looked like. We found a few interesting candidates to research like Veeva Systems and Paycom Software. They were both consistently profitable and looked fairly cheap, which is a rare combination in software.

I still don’t know if I can buy any of these stocks though, no matter how cheap they get. Software seems like a crapshoot. I have no confidence in competitive moats, terminal value, or why one software platform is better than another. Essentially, everything I need to have confidence in to make an investment is missing.

And there are an endless amount of software companies. Take Dayforce, a company neither of us had heard of until the live recording.

According to its website, Dayforce helps you “Realize the full potential of your workforce with HR, payroll, workforce management, and more in one powerful HCM solution.”

Have I not read this exact same thing on 20 other investor relations pages? And yet, Dayforce apparently has a market cap of $8 billion and generates $1.5 billion in revenue.

Do I have any clue why customers will stick around at Dayforce? Do I have any confidence a competing product won’t undercut them on price? Do I have any idea whether a new start-up is going to sprout up 12 months from now with a better solution?

It is so easy — relatively, of course — to start a software platform in 2024 compared to 30 years ago.

I mean, just look at the famous marketing technology landscape graphic:

And that is just marketing!

Perhaps you work in this industry and can figure out why one company has a technological advantage (or any other advantage) that can lead to outsized and efficient revenue growth. Efficient means growing while not burning a ton of cash each year.

However, I think there are very few investors who could have these insights and very few software stocks that exhibit these two traits (growing while profitable).

And that makes it a tough pond to fish in. Why would I spend so many hours studying this sector then?

In software, it is rare to find network effects, economies of scale, or a brand that matters.

Yes, there are high switching costs. I’m no expert on the company, but I believe this is one of the key insights to what makes Constellation Software so successful. Churn can be low from existing customers, so if you buy at a cheap price the cash flows are predictable.

The problem is, software stocks have not traded at dirt-cheap prices for the last 10 years:

(chart from the Clouded Judgement newsletter)

That pandemic software bubble was absurd. What a time.

Expensive stocks with a ton of competition that are hard to understand and seem to have 20 copycats springing up every day. Not exactly the best recipe for strong long-term returns for shareholders.

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