PVC SaaS Index™ | Q1 2023 – SaaS Companies Are Now a Bargain vs. S&P 500

Practical Summary:

  • The PVC SaaS Index™ now trades at 6.9x EV / LTM revenue, slightly up from the 6.3x multiple that we observed at the end of Q4 2022, which was the lowest multiple since early 2017.
  • Over the past 5 years, the index has averaged 10-11x, so it is now 35% below that level.
  • SaaS companies represent the best relative bargain compared to the S&P 500 than they have in years. While SaaS companies are trading well below their 5-year average (and roughly in line with the 10-year average), the S&P 500 has moved into what we call a “Danger Zone” because the PVC Equity Risk Premium™ over BBB bonds is at the lowest point since 2007.

This post is an update in a quarterly series of posts that tracks the PVC SaaS Index™, a basket of publicly traded US-listed SaaS companies.

Background: SaaS Multiples in Public Markets

Software as a Service (“SaaS”) has been around longer than the cool new cloud. The SaaS category shares some aspects of cloud computing, but its focus tends to be clearer: SaaS is the delivery of software applications over the Internet from a server hosted by the SaaS provider somewhere far away.

The first big SaaS IPO was Salesforce (NASDAQ: CRM) in 2004. Almost 20 years later, we have more than 100 pure-play SaaS/cloud companies in our proprietary PVC SaaS Index™. These companies all trade on the NASDAQ or the NYSE. They derive most of their recognized revenues from long-term contractual commitments (12 months or greater) and recognize those revenues periodically over the life of those contracts.

As of Q1 2023, we have removed several SaaS companies from the index that have gone below $1B market cap, essentially becoming broken IPOs or “zombies” in the public markets, with low liquidity / high volatility and uncertain public company prospects. These companies include Blend Labs, OneSpan Inc., Sumologic, Agora Inc., Presto, and Weave Communications Inc. A few other companies have recently delisted by being acquired and going private again. That currently leaves us with 105 publicly traded SaaS companies in the US. No new companies were added to the index this quarter.

The figure below shows the historical EV / TTM (enterprise value to trailing 12-month revenues) going back to 2014.

The multiple of 6.9x is Q1 2023 is exactly the same as the median SaaS multiple in early 2017.

Figure 1. Historical SaaS Valuations
Data Source: CapitalIQ; PVC analysis. Q1 2023 is end of day on March 9,2023.

The multiple of 6.9x is Q1 2023 is exactly the same as the median SaaS multiple in early 2017. The top quartile of SaaS companies (those whose multiples are higher than 75% of the group) are now at 10.8x, just slightly higher than they were back in 2017. That elite group has fallen by about 60% from its peak, set during the period from Q4 2020 to Q2 2021.

Performance of SaaS Stocks in Q1

Fundamentally, this SaaS group on average is delivering outstanding growth and results in the public markets. With most of the companies now reporting their Q4 results, we looked at the YoY growth in revenues delivered by these companies. The median SaaS company reported a 24% YoY increase in revenues in Q4 2022; the top quartile of fastest-growing companies grew at +38% YoY, which is extremely rare to find for a whole sector of public stocks.

Broader US S&P 500 Now in the Danger Zone

SaaS stocks now seem relatively cheap on a historical basis. Their EV / sales ratio is below where it has trended on average for the last 5, 10, or 15 years. Meanwhile, US stocks have recently entered a “Danger Zone.” Because of their risk and volatility, equities typically offer a premium over fixed-income securities, an equity risk premium that provides additional reward for investors in exchange for the higher risk.

Compare the S&P 500 Earnings Yield (which is the sum of retained earnings for those stocks plus the dividends that they pay out on a trailing 12-month basis) to the Effective Yield of BBB-rated corporate bonds in the ICE Bank of America Index and you can see that on average equities provide a 10-200 bp advantage over bonds. We call this the PVC Equity Risk Premium™.

Equity Risk Premium = difference between the S&P 500 Earnings Yield and the BBB Bond Yield
S&P 500 Earnings Yield (or inverse price-earnings ratio) = trailing 12-month earnings divided by index price
BBB Bond Yield = effective yield of the ICE BofA BBB US Corporate Index

As corporate bond rates have soared since the start of the year, the PVC Equity Risk Premium™ has dropped to the lowest reading since 2007, which means that the tech sector represents a relative bargain when compared to the rest of the market.

Figure 2. Historical Equity Risk Premium for S&P 500 Stocks

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