Why Snowflake, MongoDB and Datadog crashed today

What happened

Cloud Software Disruptor Actions Snowflake (SNOW -8.11%), MongoDB (MDB -7.46%)Y data dog (DDOG -7.18%) fell sharply today, down 7.7%, 6.6%, and 6.2%, respectively, at 3:02 p.m. ET.

None of these companies had major news today; however, the combination of a higher-than-expected inflation report and weak earnings from its software peer docusign (DOCU -24.53%) it was enough to bring down these growth leaders.

And that

The Bureau of Labor Statistics released May inflation data this morning, which came in hotter than expected. Headline inflation was 8.6%, versus 8.3% forecast, and even “core” inflation, which excludes volatile food and energy prices, came in at 6%, versus 5.9 % predicted.

With inflation already high, the surprise likely prompted many investors to immediately price in more interest rate hikes by the Federal Reserve this year. The 10-year Treasury note rose sharply to 3.17% at one point, before retreating to 3.15% at the time of writing. The higher long-term bond yields, the higher the discount rate investors can apply to stocks. With Snowflake and MongoDB still posting significant operating losses under generally accepted accounting principles (GAAP), and Datadog nearing break-even, most of the value of each of these stocks lies far in the future. But the higher long-term interest rates are and the further away earnings are, the less those future earnings are worth.

Additionally, DocuSign’s poor billing guidance in its Q1 earnings release last night cast a doubly sour mood in the cloud software space. Although DocuSign’s revenue exceeded expectations for the current quarter, up 25%, management expects revenue growth of only 6-7% this year.

Revenue growth is perhaps more important than revenue in many cases for software companies. This is because the billing incorporates the change in revenue as well as the change in deferred revenue from the initial subscriptions. While top revenue includes monthly revenue from subscriptions signed in the past, billing captures all of the new growth for the quarter.

DocuSign saw huge uptake during the pandemic, when businesses large and small were forced to go digital in no time; now that the pandemic is receding, there seems to be an “air pocket” in its growth. The sell-off across the software-as-a-service (SaaS) sector seems to indicate that investors are nervous that DocuSign’s billing slowdown will also affect these top names.

In fact, while all three of these names have posted fairly solid gains recently, they have also been headed for a slowdown this year, albeit at a much higher rate of growth. Snowflake recently reported product revenue growth of 84%, but headed for 66% annual growth at the midpoint. MongoDB recently reported 57% growth, but its full-year guidance projected growth of just over 35%. Datadog just posted an impressive 84% revenue growth rate in the last quarter, but is targeting 56% revenue growth for the full year.

These are much stronger growth numbers than DocuSign, but these three stocks also trade at a much higher price-to-sales ratio:

SNOW PS Ratio Chart

SNOW PS Ratio Data by YCharts

Now what

Given that all three of these stocks are disruptive in their fields and have really excellent growth rates, and since they are down a lot from their highs, one might think that they are a bargain right now.

However, I would caution investors against this notion. Each of these companies went public in recent years, when interest rates were at or near zero. Plus, they all absolutely took off during the pandemic, as the push for digitization across the company skyrocketed. While these companies may not see as bad a decline in growth as DocuSign, they will likely show a slowdown, if anything because it’s harder to grow at sky-high rates the bigger you get.

Meanwhile, there is no way of knowing how high interest rates will be. As today’s price action showed, these stocks could soar higher if interest rates show signs of peaking and falling again, or they could fall further if long-term interest rates continue to rise. If you own these stocks, be prepared for volatility and make sure you have a reasonable idea of ​​the intrinsic value, based on estimated future earnings and a reasonable discount rate, as a benchmark.

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