saas

Top 10 SaaS stocks

Alvin Chow
Alvin Chow

Software-as-a-Service (SaaS) stocks have been the best performers in 2020. The transition from on-premise systems to the cloud is in motion and there’s no going back.

Companies need to be more nimble now and subscribing to SaaS helps them avoid the large investments required for on-premise systems. Not only capital are locked up with the equipment, it would be difficult to reverse it when the company takes on a new direction, which could render the equipment useless. So it is a matter of time until majority of the enterprises switch to the SaaS model. There’s still a lot of investment opportunities in SaaS in case you are wondering if you are late to the game.

The number of SaaS stocks have ballooned in recent years, capitalizing on the insatiable appetite of the investors. But not all SaaS companies are good and conventional investment metrics are often not the best way to analyze SaaS stocks. For example, a profitable SaaS company may not be better than a loss-making SaaS company. And PE ratio is meaningless with a loss-making stock.

Public Comps is an excellent site that offers analysis on SaaS stocks. A free account provides a number of metrics for you to play around, while the paid version is likely to be an overkill if you are not familiar with SaaS yet.

Public Comps has identified the top 10 SaaS stocks on its site based on their criteria (which I have no luck trying to uncover).

It is a good starting point if you are dipping your toes into the world of SaaS. Here’s the list:

#1 Zoom (NASDAQ:ZM)

Zoom has become a verb and an adjective in video conferencing, just like what Google is for search. Covid-19 was a boon for Zoom as teams needed to coordinate and discuss remotely during the lockdowns.

Dr Wealth is a customer of Zoom too and you might have even attended one of our webinars via the platform.

Zoom isn’t the most revolutionary software today as many provide such video conferencing services – some of the big names include Cisco (WebEx), Google (Meet) and Microsoft (Teams). So, how did Zoom cut a market share for itself?

I think it is because Cisco has such an entrenched large corporate customer base, they couldn’t even be bothered by Zoom, whereas Google and Microsoft believed that their product bundle (with email, office productivity suite and cloud storage) are too sticky for anyone to switch. Hence, they paid little attention to the video software and made little improvements to it – they have many billion dollar businesses to look after by the way.

That’s where Eric Yuan (founder of Zoom) found a gap. He was previously from Cisco and at some point he was ashamed when customers questioned about the software usability. The only way to change it is to leave the organization to start his own. He did and the rest is history.

That said, the chances of success ain’t that high. It doesn’t mean that any startup that observed a gap in the market will automatically enjoy a windfall. The internal execution must be great and the external environment must be favorable.

Well, Zoom definitely had both on its side. Eric executed well and really focused on the users, making Zoom the most user friendly video conferencing software in the market for the most diverse customer base. With a stroke of luck, Covid-19 made it rain gold into Zoom’s bank account.

Taking some numbers from Public Comps, Zoom grew 355% in the latest quarter as opposed to the same quarter last year. The next fastest growing SaaS was Peloton (NASDAQ:PTON) with 232%.

But Zoom isn’t the most expensive SaaS stock (it is second). Snowflake (NYSE:SNOW) is. That is if we use the EV/Revenue in the next 12 months (something that is close to Price / Sales if you need an analogy) Snowflake was trading at 82x while Zoom is at 38x.

In contrast, Amazon is trading at 4x. This shows that the investors really value SaaS stocks very highly. If they are the Beth Harmons, the big tech companies are the Vasily Borgovs (did you watch The Queen’s Gambit? nvm.)

#2 Shopify (NYSE:SHOP)

Shopify is the antithesis of Amazon – while Amazon aggregates all the products and sellers on its platform, Shopify decentralizes selling and simply offer individuals an easy way to set up their digital shop front. If Amazon is NTUC Fairprice supermarket, Shopify is Econ minimart (it is still around if you are wondering).

Shopify provides a turnkey solution for anyone who wants to do all of the following in one place:

  • sell something online,
  • collect payment via their own storefront (physical retail as well),
  • market their products on social media,
  • sell on major e-commerce platforms, and
  • track their sales and inventories.

Nowadays, a business can’t do without a web presence even if it is primarily a brick-and-mortar one. Even restaurants saw the need to get online and sell deliveries during the lockdown period. Retail shops were scrambling to put themselves on the digital world when they couldn’t open in their physical locations.

Increasingly, every business is trying to get in front of customers on a variety of platforms. Instead of building another e-commerce platform, Shopify sells ‘shovels and picks’ to the e-commerce gold miners. Small medium enterprises pay Shopify a subscription fee to use the software to operate their businesses online.

Shopify grew its revenue by 95% in the recent quarter compared to a year ago and it is now trading at EV/Revenue next 12 months of 33x.

#3 CrowdStrike (NASDAQ:CRWD)

Security is something that everyone needs but often takes for granted – we don’t see anything wrong if security is doing its job while we would definitely be horrified when security fails. This applies from national defence, right down to the local security of your residence and office.

Cybersecurity has to keep up with all the activities in the digital world. More data and transactions are being done digitally and it has become more lucrative for hackers to steal information and siphon money. Lax cybersecurity measures just makes the job easier for the hackers. Did you realize that stolen customer details episodes have been rising?

CrowdStrike is a cybersecurity SaaS that secures your end-point devices (laptops, desktops, tablets and smartphones). Gone are the days where you buy a security software and update the virus definition on your device. It is a lot more convenient to have the software on the cloud so that the update happens in one place and replicated for all devices. You just need to pay a subscription to be protected.

Almost everyone owns an internet-enabled device in a modern city and sometimes these devices are connected to the workplace IT environment. This introduces multi-access points and vulnerabilities for the hackers to exploit. The transition to work from home due to Covid-19, introduced a whole new realm of vulnerabilities.

Hence, companies who need to protect sensitive information would consider subscribing to CrowdStrike to ensure that every device that is accessing the companies’ networks is monitored. This becomes a necessary perennial tool going forward.

CrowdStrike grew 84% in the recent quarter compared to a year ago and it is now trading at EV/(Revenue next 12 months) of 29x.

#4 Datadog (NASDAQ:DDOG)

Unless you are a programmer (in particular those who are in charge of DevOps or IT operations), you wouldn’t have any use for Datadog.

I am not a programmer myself so you would notice that I do not have much to say about Datadog here. The superficial knowledge that I have is from Dr Wealth’s small setup to build our stock app.

Agile software development allows smaller startups to innovate faster than the big incumbents. The process of software development has shortened considerably and deployment onto the live site has to be fast, seamless and yet stable enough to not crash the system.

DevOps is a role that emerged from this agile framework that aims to allows software to iterate quickly – put the changes out, track user behavior and make changes again. You would notice some apps have new features and functionalities very regularly and that’s because they run agile development.

Since you are messing with the actual live site, you don’t want any downtime and Datadog exists to make DevOps’ lives easier. One can monitor the activities on the live site, pinpoint any instability or even offer predictive analysis on the overall network all on one platform.

Datadog grew 61% in the recent quarter compared to a year ago and it is now trading at EV/(Revenue next 12 months) of 35x.

#5 Twilio (NYSE:TWLO)

Twilio is not exactly a SaaS but more of a Platform-as-a-Service (PaaS). This means that you would need programming knowledge to build useful applications on top of it. You can pretty much customize the features you want on Twilio or integrate it with other software such as Microsoft BI. Hence, unlike a SaaS, you can’t subscribe and expect it to be user friendly to a non-programmer.

Twilio is a one-stop platform to manage all your communications, be it email, SMS, phone call, video call, WhatsApp, Messenger and more. This would help a lot of businesses automate replies to customers. I can think of e-commerce and delivery services where businesses need to confirm customers’ orders and schedule delivery timings. Given the volume of orders, it would require a massive team of humans to message manually. Twilio automates and enables a leaner workforce, thereby saving costs for the companies.

But it isn’t just about automating but also enabling customer service staff to engage the customers better. For example, the same customer may communicate with a business via Messenger at the first touchpoint but uses email to reply subsequently. Twilio will track these interactions and any customer service staff would be able to quickly know how to pick up the conversation from where it left off.

Twilio grew 52% in the recent quarter compared to a year ago and it is now trading at EV/(Revenue next 12 months) of 19x.

#6 Slack (NYSE:WORK)

I always wondered why a working tool is called ‘Slack’. Oxymoron isn’t it?

Slack is actually an acronym for Searchable Log of All Conversation and Knowledge. That’s long and boring. Slack is definitely easier to remember.

Email has been the core communication channel at work but email has became cumbersome and slow with the advent of messaging apps such as WhatsApp. While colleagues can take their time to reply or even ignore your emails, it is a lot harder to ignore messages. Response time for messages are shorter than emails too. I don’t know about you but I find myself increasingly using WhatsApp to communicate at work.

However, WhatsApp is not built to archive communication threads properly. It is hard to search for something you vaguely remembered was discussed. Slack is here to solve all that. Use chat as a primary means of work communication and archive organizational knowledge automatically along the way.

Slack grew 49% in the recent quarter compared to a year ago and it is now trading at EV/(Revenue next 12 months) of 14x.

#7 Zscaler (NASDAQ:ZS)

Some of these SaaS companies can be quite technical and difficult to understand – Zscaler falls into this category. I am not an expert in IT and cybersecurity but I’ll try my best.

The easiest way is to think of Zscaler, is as a gatekeeper. While CrowdStrike secures the devices, Zscaler secures the network. It acts as an intermediary between your company’s network and the bigger internet, monitoring the traffic in and out of it.

The challenge is to stop malicious attacks while allowing legitimate users to pass through, without slowing them down.

Zscaler grew 46% in the recent quarter compared to a year ago and it is now trading at EV/(Revenue next 12 months) of 29x.

#8 Elastic N.V. (NYSE:ESTC)

Elastic offers a search function for enterprises. You must be thinking why would a company pay for such services. Well, Dr Wealth actually pays for one (we use Elastic’s competitor, Algolia). We deployed it on our Dr Wealth app for you to search stocks. Instead of coding a search function from scratch or modifying an open source version, we decided subscribing to a SaaS as it would be faster and better for user experience. This is because such search software has machine learning baked in and would get better overtime in showing relevant results to the users.

There’re also analytics to know what others are searching for and the common search terms that returned no results. We can then improve our services accordingly to what users want.

Elastic has mentioned big companies such as Microsoft, Netflix and Uber as their customers. Elastic must have provided something valuable, considering that these tech companies could have easily done it themselves in-house.

The company has also expanded to other services including cybersecurity like CrowdStrike and data visualization like Microsoft BI.

Elastic grew 44% in the recent quarter compared to a year ago and it is now trading at EV/(Revenue next 12 months) of 15x.

#9 Okta (NASDAQ:OKTA)

Okta is the third cybersecurity SaaS in this list. However, it is not a competitor to CrowdStrike and Zscaler, but instead is complimentary to them. CrowdStrike provides endpoint (device) security, Zscaler provides network security while Okta provides identity authentication.

You can identify employees with staff pass and passcodes to allow entry to a physical office. With remote working, how would you know if a person is indeed authorised to access the company’s network? Online user authentication is needed.

Today, many companies are subscribed to a myriad of SaaS such as Microsoft 365, G Suite, Slack and Zoom. It would be a nightmare for the user to have to authenticate on every single software. Okta offers a Single Sign On service on popular cloud software. Sign in once and you breeze through the work processes without having to authenticate again even when you switch between softwares.

Okta grew 43% in the recent quarter compared to a year ago and it is now trading at EV/(Revenue next 12 months) of 31x.

#10 Coupa (NASDAQ:COUP)

My first encounter with Coupa was to invoice DBS for an ad campaign. That the biggest bank in Southeast Asia chose a SaaS for all its business spending is telling that Coupa has gained recognition and that the future is already here. The days of on-premise chunky and expensive customized enterprise software are coming to an end.

Such cost management software has a very clear ROI. Suppose you can save $10m with a software that cost $1m, most bosses would say yes. Especially in large enterprises where it is impossible to scrutinise every single expense, a few black sheep may take advantage of lax cost control measures. Coupa provides the technology to track expenses efficiently and help management with the analysis.

There’s even predictive analytics that can help forecast future expenses, allowing the finance department to better plan and manage their cash flow.

Coupa grew 32% in the recent quarter compared to a year ago and it is now trading at EV/(Revenue next 12 months) of 37x.

Rounding up…

SaaS stocks have matured and proved to have product-market fit. Some of them may still be in losses but it might be because they are spending more to capture market share as fast as they could. The customer acquisition costs should go down over time and these SaaS companies would turn profitable.

The venture capitalists were early in this game and have already reaped the rewards for the risks they have undertaken. But it is not too late for retail investors as many of these SaaS companies are still growing very fast and have a long runway ahead.

What do you think of SaaS stocks? Do you have a favourite that was not covered in this list? Let me know in the comments below.

Alvin Chow
Alvin Chow
CEO of Dr Wealth. Built a business to empower DIY investors to make better investments. A believer of the Factor-based Investing approach and runs a Multi-Factor Portfolio that taps on the Value, Size, and Profitability Factors. Conducts the flagship Intelligent Investor Immersive program under Dr Wealth. An author of Secrets of Singapore Trading Gurus and Singapore Permanent Portfolio. Featured on various media such as MoneyFM 89.3, Kiss92, Straits Times and Lianhe Zaobao. Given talks at events organised by SGX, DBS, CPF and many others.
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