The opposite of euphoria is panic - The On-Demand Software Index

   

The Demand Index (ODI) was down 8.0% today (Tuesday, October 07, 2008), down 43.2% year-to-date (YTD) and stocks within the index are down an average of 57.0% from their 52 week highs. This compares to the iShares S&P GSTI Software Index Fund(IGV) - 6.7% today, -32.1%, YTD and -35.0% from its 52 week high. The YTD performance of the major indices (as of today’s 10/7 US markets close): Dow -28.8%, S&P 500 -32.2% and Nasdaq Composite -33.8%.

 

Even though many of the companies within this index have been performing quite well from a business perspective this year, it is not surprising that these stocks have been hit harder than their software peers for several reasons:

 

First, On-Demand software is an emerging market with many new entrants and the constant competitive threat of larger software firms entering the market.

 

Second, many of these firms are not making a profit and may need cash infusions in the future. With the IPO market stalled and a constrained corporate credit market it may not be as easy to get needed cash.

 

Finally, momentum stocks go up faster in a Bull market but also go down much faster in a Bear market. There are exceptions to this rule but in general many of these stocks were “priced for perfection” and that perfection included a growing economy not just excellent corporate execution.

All the stocks in the index have loses YTD with the best stock, Blackboard Inc. (BBBB), down only 15.8% YTD and only 32% off from its 52 week high. That beats the major indices but in a misery love company sense.  

 

salesforce.com (CRM), the premier On-Demand software company by many metrics,  was placed on the S&P 500 stock indexlast month but even that action has failed to stop its stock from sliding 42.7% YTD and 52.2% off its 52 week high. Within the last week UBS cut its rating from a Buy to a Sellbased on its channel check of consultants that indicated a slight drop in utilization rates and a lengthening of the sales cycle on enterprise deals.

 

Most of the On-Demand software companies on this list have a solid business along with their fine technology and should do fine in the long-run. These stocks are likely to bounce with either movement of the major indices or when there is a rotation into tech stocks. Market upticks may have more to do, in the short run, with economic or political events than with company fundamentals. 

 

However, some cautionary notes for those feeling like these stocks are a “screaming buy.” Do not confuse a “dead cat bounce” with an all clear sign. In August we experienced a bounce and there were a rash of articles or blog posts speculating that it was time to buy these stocks. Maybe we are at or near a bottom now but I am not sure whose crystal ball answers that question.

Given enough time the overall markets should correct and exceed previous highs. The length of time to rebound, i.e. , move from trough to peak , may take months or years depending on the severity of the recession or slowdown.  Individual stocks, on the other hand, may not rebound markets may not rebound fully.  

 

Disclosure: I have no current stock positions in any of the companies listed in this index and no current business partnerships.

Comments

[Vincent McBurney]

I think the share market is dodgy on the best of days but this crisis has made it insanely difficult for small IT companies to get a fair price.
Informatica has been hit quite hard. A Piper Jaffray analyst said:
"we believe investors are pricing in an illogical long term growth rate of roughly 7%, whereas Informatica has grown more than twice as fast as the broader software industry for the past 3 years (i.e. 20%+). This has resulted in what we view to be one of the widest valuation-versus-fundamentals discrepancies in our coverage list."

Three years ago Informatica was at about $11 a share, three years of +20% growth later and they are back to $11 a share!

I agree. In bear markets like this everyone gets punished and, in particular as you point out, the small IT vendors such as Inforamtica (INFA).

I did see Piper Jaffray’s analyst Mark Murphy comments that you quoted which was encouraging (or depressing if you were wondering why then has the stock been punished.)

He also upgraded INFA stock from Neutral to a Buy. His price target is $16. INFA was up today 1.50% to 11.48.

It is great to see an analyst make a call before a huge move has occured.

Is he too early? Marketing timing is extremely tough in this market. It may be early but it is well reasoned.

At some point he'll be right because INFA has been performing well. Their business will be impacted by a recession that constrains corporate spending. The size of the impact will depend on the size of the recession.

Informatica's P/E of 19 is reasonable when coupled with a 20% growth rate. The P of that equation (P/E) may go down in a recession though.

Informatica, and several other firms in the BI index, should do well as the market and economy rebounds...whenever that happens.