This year has been a historical year for the stock market. At a time when major economies have cratered because of the pandemic, the stock market has rallied. Riding primarily on the back of federal monetary and fiscal support that has placed money in the hands of consumers, stock market returns have rewarded investors, particularly in the tech sector. The biggest beneficiaries of the stock market rally so far this year are tech stocks.
When we talk about technology, it is broadly divided into hardware and software. he tech-heavy NASDAQ composite crashed to around 6,900 points in March and then surged to the 12,000 mark in September as the entire world adopted stay-at-home technologies of many kinds The pandemic-induced lockdown encouraged people across the globe to work, learn, shop, and even entertain from home. Cloud-based software stocks rallied significantly between April and September. Some of the biggest beneficiaries of the pandemic were Amazon (AMZN) and Zoom Video Communications (ZM).
While the move to the cloud is here to stay, many cloud stocks' growth stagnated in September. The rally, which was fueled by pandemic fears, started to ease as the earnings reflected the impact of the pandemic. Investors could then to a degree quantify the pandemic and set realistic earnings expectations.
In this post-pandemic market, in which growth is expected to normalize, a few tech stocks have the potential to continue their accelerated growth.
Traits of a high-growth tech stocks
While past performance does not guarantee future performance, there are some common traits among high-growth tech stocks, especially SaaS (software-as-a-service) stocks. An SaaS business model converts traditional software licensing to subscription-based services that give flexibility to customers. The idea behind SaaS is to put software on the cloud. It allows subscribers to access the software from any device that has a stable internet connection.
The flexibility and ease of adoption of SaaS came in handy during the pandemic when most companies adopted a remote working culture. This brought home to companies the importance of remote working and the cost-benefit it brings. Digital transformation is the driving trend currently, and cloud computing, big data analytics, and artificial intelligence (AI) that come next will only make work from home more efficient. Many companies might adopt a hybrid approach to on-premises and at-home work to give employees flexibility, improve productivity, and reduce cost. This sea change in the working habits will drive SaaS stocks even when people return to offices.
Analyzing SaaS stocks
SaaS companies have low capital requirements and therefore have low or no debt. When analyzing a SaaS stock, one should look at three metrics: Subscription revenue growth rate, the increase in the number of high revenue-generating customers, and operating margin.
SaaS companies enjoy hyper-growth in the early stages as more clients adopt their services. But many companies fail in the high-growth stage because they are unable to retain customers. Only the companies that succeed in retaining customers for the long term and cross-sell products to existing customers will survive. Such companies generate higher profits and recurring revenue and gain market share.
Some of the best software stocks with the potential to earn significantly in the post-pandemic world are ServiceNow, Inc. (NOW), Atlassian Corporation Plc (TEAM), and Nuance Communications, Inc. (NUAN). These stocks have surged 35%-60% last year and 85%-135% this year as the pandemic accelerated the trend towards remote working and digitization.
ServiceNow, Inc. (NOW)
NOW provides cloud-based workflow automation software. It helps more than 6,200 customers automate services like IT, human resources, customer support, governance, and compliance. Approximately 80% of its customer base are Fortune 500 companies. Its revenue surged 30%, and total customers rose 25% year-over-year in the third quarter. Its revenue rose faster than customer numbers because it attracted larger enterprises, including large federal organizations like the US Air Force and the US Army. NOW has a 98% retention rate that hints at its growth potential. Moreover, it operates at a 21% margin.
The pandemic had a dual impact on NOW. On one hand, the economic weakness has shifted enterprise focus on increasing productivity to survive the pandemic crisis, thereby increasing demand for the NOW platform. On the other hand, the pandemic has hampered some businesses, negatively impacting NOW's contract renewals and new customer contracts.
As the economy recovers and the business environment improves, the demand for NOW platforms should surge as companies adopt a hybrid approach to remote and in-person work. Analysts expect NOW’s revenue to grow 30% this year and 23% next year. The stock is trading at 25 times its sales per share, which is normal for high-growth stocks.
How does NOW stack up for the POWR Ratings?
A for Trade Grade
A for Buy & Hold Grade
C for Industry Rank
B for Peer Grade
A for overall POWR Rating
The stock is also ranked #1 stock in the 48-stock Software - Business industry.
Atlassian Corporation Plc (TEAM)
TEAM provides a set of seven team collaboration software packaged that help teams collaborate at all stages of a project. TEAM designed its product suite specifically for software developers, but it is now gaining traction in the non-IT market as well. It earns two-thirds of its revenue from Jira —a team planning and project management tool — and Confluence — a content creation and sharing tool.
TEAM adopts a land-and-expand model where a small team starts using a free version of its software. As the project complexity grows and team size increases, TEAM hopes he stickiness of its tools encourages users to upgrade to paid versions. And when one team uses TEAM tools it spreads to the entire organization.
TEAM focuses on increasing its revenue from existing customers. In the fiscal 2021 first quarter ended September 30th, TEAM’s collaboration went to the next level as many people were working from remote locations. TEAM added more than 8,600 new customers versus 3,000 new customers in the previous quarter. Analysts expect TEAM’s revenue to grow 17% in fiscal 2021. The stock is trading at 32.5 times its sales per share.
TEAM stock is rated “Strong Buy” in our POWR Rating system. It also has an “A” for Trade Grade, Peer Grade, and Buy & Hold Grade, and a “B” for Industry Rank. In the 96-stock Software - Application industry, it is ranked #3.
Nuance Communications, Inc. (NUAN)
Not all high-growth stocks are new businesses. Some are companies that undergo restructuring to target future growth potential. NUAN is such a company. It is transitioning from a licensing model to a cloud subscription model.
NUAN has been providing speech recognition and artificial intelligence (AI) solutions since 1992. It merged with ScanSoft in 2005, and since then has been growing through acquisitions. In 2019, NUAN embarked on a new era of growth, streamlining its portfolio, and focusing on fast-growing verticals of healthcare and enterprise. It is developing technology for intelligent engagement, security, and biometrics.
In fiscal 2020 ended September, NUAN’s revenue fell 2.7% to $1.48 billion as it is transitioning its customer base to the cloud. The 1.4% increase in cloud services revenue was offset by a 12.6% decline in licensing software revenue.
Many traditional software companies have revived their growth by transitioning to the cloud. As the world moves towards AI, we believe there will be a growing demand for speech recognition software. Once NUAN completes its transition and taps fast-growing markets, its revenue growth should accelerate. Analysts expect its revenue to grow 7.7% in fiscal 2021.
NUAN stock has surged 135% this year and is trading at 8.3 times its sales per share. It has a relatively lower valuation than other high-growth stocks as the company’s sales are yet to reflect its growth. But it is heading on the right path and has significant growth potential.
NUAN stock is rated “Strong Buy” in our POWR Rating system. It also has an “A” for Trade Grade, Peer Grade, and Buy & Hold Grade, and a “B” for Industry Rank. In the Software - Application industry, it is ranked #12.
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NOW shares were trading at $531.61 per share on Monday afternoon, up $5.91 (+1.12%). Year-to-date, NOW has gained 88.30%, versus a 16.09% rise in the benchmark S&P 500 index during the same period.
About the Author: Puja Tayal
Puja is a seasoned writer working with financial publishing companies like Motley Fool Canada and Market Realist. With over 13 years of experience in the field of fundamental research, she brings a blend of comprehensive, well-researched insights into her articles.
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