Software-as-a-service (SaaS) companies are one of the more exciting groups of growth companies in the market today. Many SaaS companies are growing their businesses at lightning speed, boast giant addressable markets, fat gross margins, and have sticky user bases.
With the recent drop in SaaS valuations, it may be a good time now to take a look at which SaaS companies are offering the best valuations and growth.
Scatterplot of SAAS companies
In his recent weekly update on SaaS stocks, venture capitalist Jamin Ball provided a scatterplot of US-listed SaaS companies based on their growth and enterprise-value-to-next-12-months (EV-NTM) revenue multiple.
The horizontal axis shows the companies’ NTM consensus growth rate, while the vertical axis shows their EV-NTM revenue multiples.
Companies that are further right on the scatterplot are growing the fastest and the companies that are higher up have the highest valuation multiples.
The companies that are expected to grow the fastest in the next 12 months tend to also sport the highest valuation multiples. This is why we see that companies that are further right on the scatter plot tend to be higher up too.
For example, at the most top right of the chart, we see Snowflake Inc (NYSE: SNOW) which is, by some distance, the company that is expected to grow the fastest among US public-listed SaaS companies. It also has the highest EV-NTM revenue multiple at more than 50.
The cheapest SaaS companies today
As investors, the companies that may be the most attractive are those that are further to the right and to the bottom.
The blue line running across the scatterplot is what is statistically called the fitted regression line. This line shows where the companies tend to place in the scatterplot. Anything under the line can, therefore, be considered cheaper than average and vice versa.
From the chart, there are a few notable companies that are trading below the fitted regression line.
These include companies such as Zoom Video Communications Inc (NASDAQ: ZM), Crowdstrike Holdings Inc (NASDAQ: CRWD), Twilio Inc (NYSE: TWLO) and even Snowflake inc.
Notable companies that are above the line are Bill.com Holdings Inc (NYSE: Bill), Cloudfare Inc (NYSE: NET) and Shopify Inc (NYSE: SHOP).
Other things to consider?
While the scatterplot does give us a good comparison of the growth and valuation of SaaS companies, investors have to consider other factors too.
Some important things to consider include:
- Sustainability of growth: The chart only shows the consensus growth estimate for the next 12 months. Companies that can sustain growth at a high rate for a long time, or accelerate their growth beyond the 12 months consensus, should warrant a higher multiple. Factors that can affect sustainability are balance sheet strength, management capability, size of the addressable market etc.
- Margins: Investors tend to use revenue multiples to value non-profitable SaaS companies. This makes sense due to the absence of profit but as revenue is a high-level metric, it tells us little about the company’s eventual profitability which is what counts in the end. As such, companies that boast higher gross margins and the ability to increase operating leverage warrant being priced at a higher multiple
- Organic vs inorganic growth: Related to the sustainability of growth, the type of revenue growth is also important. If the growth is coming from the consolidation of revenue due to an acquisition, then this revenue growth will be a one-off.
An exciting place to invest…
Thanks to the ease and affordability of SaaS products, they have increasingly become part and parcel of not just everyday business dealings, but everyday life. From customer relations management to human capital resource management to video communication, SaaS has become something we can’t live without.
With the scalability of the cloud and the relatively tiny incremental cost of deploying the product to each new customer, SaaS companies enjoy operating leverage and immense growth potential. Gartner predicts that SaaS revenue will grow from US$104 billion in 2020 to US$140 billion in 2022.
Investors who are keen to invest in the space should consider valuations, growth, sustainability of the growth, and profit margins.
Note: An earlier version of this article was published at The Good Investors, a personal blog run by our friends.
Disclosure: Jeremy Chia owns shares in Shopify, Twilio, and Zoom.