On-Demand (or SaaS) Index: Fundamentals Matter

“Failing to Plan is Planning to Fail”, Part 1
June 23, 2008
TDWI Boston Chapter Users’ Meeting July 16th
July 4, 2008
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On-Demand (or SaaS) Index: Fundamentals Matter

Ondemandindex_2 The On-Demand Index (ODI) is down 18.55% YTD. This compares to YTD performance:  iShares S&P GSTI Software Index Fund (IGV)  -7.69%, Dow -14.46%, Nasdaq Composite -12.69% and S&P 500 -12.94%. But the stocks in the ODI vary widely from a 24% YTD gain to a 69% loss.

The stocks recording a YTD gain include: The TriZetto Group, Inc. (TZIX), Ultimate Software Group Inc. (ULTI), Salesforce.com (CRM) and Kenexa Corporation (KNXA). Although these four companies vary widely in what they sell they have several key business attributes in common:  profitable (earnings now), applications that businesses need in growth and recessionary climates, ability to beat out competitors (even much larger companies with deep pockets) and, a reasoned business growth plan.

Odi_2008_06_29_copy_2 

This does not imply that the other companies in this index are not as good companies (you have to pick your criteria for what that means) as the top stock gainers but that investors have not felt their stock prices at the beginning of this year were as justified as the top gainers. Fundamentals matter, especially when the bull is taken over by the bear. There were a number of articles and posts about these companies being recession-proof but that is different than the stocks being bear-proof. Any of these companies in the ODI may be good investments at (different) times but you have to do your homework about the company’s products, revenue and earnings prospects, management team and competition. On-Demand software may be the wave of the future but that does not mean any company selling it is a good investment. In the initial hype and IPO wave everyone is seemingly a winner but we are past that wave now.

On June 25, the article in Barron’s titled “Pack the Cooler, Dump These Stock” reinforces our message of examining valuations and fundamentals in regards to tech stocks. The article stated “Stocks of some leading tech companies are trading at absurd multiples relative to the rest of the technology universe. Why, for example, is Salesforce.com (ticker: CRM) trading at a price-to-earnings (P/E) multiple of 110 times next year’s projected earnings, when Microsoft (MSFT), the largest software vendor in the world, trades at just 13 times?” many of us would have no problem making the case for why CRM should get a much higher multiple than MFST, but a 110 FORWARD P/E is pricey and has expectations built in for perfection (or acquisition.)

Eric Savitz, in his Barron’s Tech Trader Blog on June 25th summarizes Goldman’s tech analysts’ feedback on salesforce.com: Goldman says the company is benefiting from the transition to software-as-a-service; they also think it is an attractive takeover candidate. But they keep a Sell rating, noting that the stock is “priced for perfection, with a take-out premium baked in.”

Now is not the time to just buy a stock just because it is down and the company sells “cool” software. It is great to be a on-demand enthusiast but before any of these stocks become one of your investments make sure you feel the company business can meet the expectations implied by its stock valuation.

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

Note: The index is calculated on an equal-weight representation based on closing prices as of 12/31/07.

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