PVC SaaS Index™ | Q2 2023 SaaS Companies Now Trading at a Discount vs. S&P 500
PVC SaaS Index Q2/23 average at 7.4x EV / LTM revenue
Up significantly from the 6.1x multiple that closed out Q4 2022
Median multiple still below 10-year average
EV / sales ratio below its average for the last 15 years
S&P 500 looks expensive, yet tech multiples more attractive than any time since 2010
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.
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:
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.
In this index, we have removed several SaaS companies 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: Agora, Bandwidth, Blend Labs, CS Disco, Presto Automation, and SecureWorks.
That leaves us with 101 publicly traded SaaS companies in the US.
The historical EV / TTM (“enterprise value” to “trailing twelve months” of revenue) going back to 2014 is shown below.
The multiple of 7.4x in Q2 2023 is exactly the same as the median SaaS multiple in late 2017. The top quartile of SaaS companies (those whose multiples are higher than 75% of the group) are now at nearly 14x, higher than they were back then, when the elite group was around 9-10x.
The multiples of that elite group have fallen by about 50% from its peak, set during the period from Q4 2020 to Q2 2021.
Multiples Reverted to 2017-2018 Levels
Interestingly, you can draw a fairly straight, flat line back through Q4 2017. The median company in our index for Q4 2017 was also at about an 8x EV / trailing sales multiple. That multiple stayed fairly steady through-out 2018 and 2019 and all the way through the brief 5-month “COVID recession” (and ensuing market panic) that began in March 2020, when large-cap public market indices dropped by about 30% from mid-February to the end of March.
Of course, we then had a huge run-up in multiples, up to historic highs of 17-18x in late 2020 and throughout 2021. A handful of pandemic beneficiaries led the charge here. Companies like Zoom and Netflix saw huge influxes of new customer ARR to drive their top line. They gave up some of those gains as the economy normalized in late 2021, although the increase in multiples was broadly felt by almost every SaaS company.
Since the start of 2022, however, those multiples have reverted back to pre-pandemic levels. The current multiple of 7.4x is just slightly below the 5-year average and 10-year average of 9x.
Performance of SaaS Stocks in Q2
SaaS companies on average are delivering outstanding growth and results in the public markets.
With most of the companies now reporting their Q4 results, we looked at the YoY revenue growth 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”
On a historical basis, SaaS stocks now seem relatively cheap. Their EV / sales ratio is below where it has averaged 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 Earnings Yield of the S&P 500 (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 an advantage over bonds. We call this the PVC Equity Risk Premium®.
We calculate the PVC Equity Risk Premium®.using BBB bond yields are from the Federal Reserve Bank of St. Louis and the “ICE BofA BBB US Corporate Index Effective Yield.” The “S&P Earnings Yield” is calculated based on data here.
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.
In the US, the stock market had a strong Q2, with the NASDAQ up 32% YTD and the S&P500 up a solid 16%. But just seven stocks have driven almost all of the gains.
The market cap of all US stocks is now about $40T, which is $5T higher than it was at the start of the year. But just seven stocks – Apple, Microsoft, Google owner Alphabet, Amazon, Nvidia, Tesla, Meta — have ripped higher, gaining between 40-80% this year. In aggregate, the remaining 493 companies are flat.
Nvidia alone has added over $1.1T of that $5T in appreciation.
Top-heaviness in the US isn’t new. There was a “Nifty Fifty” period during the 1960s, and a period during the 1970s when oil companies dominated the index. But this level of market cap concentration by large cap tech feels extreme. For instance, Apple is worth more than the entire Russell 2000 of smaller US companies. When market breadth breaks down like this, it usually doesn’t end well. The end of the 1960s ended with a whimper, and most of the 1970s generated meager or zero real returns.
Over the past decade, the NASDAQ Composite Index has experienced five corrections, which I have defined as a 10% or greater drop from its prior intraday high. The chart below shows round sizes for Series A companies; these round sizes dipped only very slightly (if at all) during the corrections and generally continued climbing. The correlation between the NASDAQ closing value and the median Series A round size is 0.92. (See Figure 3 below.) Over the past six quarters, Series A round sizes have fallen by 24%.
Finally, Figure 4 below shows round sizes for Series D or later companies. It shows clearly that round sizes dipped during these corrections. On a quarterly basis, the correlation between Series D+ round sizes and the NASDAQ closing value is 0.88. Over the past six quarters, round sizes have adjusted much more quickly and by 63% from the peak in Q4 2021.