• Subscribe
  • Log In
  • Home
  • Daily Diary
  • Asset Class
    • U.S. Equity
    • Fixed Income
    • Global Equity
    • Commodities
    • Currencies
  • Sector
    • Basic Materials
    • Consumer Discretionary
    • Consumer Staples
    • Energy
    • Financial Services
    • Healthcare
    • Industrials
    • Real Estate
    • Technology
    • Telecom Services
    • Transportation
    • Utilities
  • Latest
    • Articles
    • Video
    • Columnist Conversations
    • Best Ideas
    • Stock of the Day
  • Street Notes
  • Authors
    • Doug Kass
    • Bruce Kamich
    • Jim Cramer
    • Jim "Rev Shark" DePorre
    • Helene Meisler
    • Jonathan Heller
    • - See All -
  • Options
  • RMPIA
  • Switch Product
    • Action Alerts PLUS
    • Quant Ratings
    • Real Money
    • Real Money Pro
    • Retirement
    • Stocks Under $10
    • TheStreet
    • Top Stocks
    • Trifecta Stocks
  1. Home
  2. / Investing
  3. / Technology

Software High-Flyers Face High Expectations -- Just Ask Microsoft and SAP

Wall Street's cool response to Microsoft's strong earnings report, and its harsh response to SAP's mildly disappointing report, shows that many enterprise software stocks are now dealing with a small margin of error.
By ERIC JHONSA
Jul 19, 2019 | 03:52 PM EDT

Microsoft (MSFT) is now up just fractionally after delivering a very strong earnings report and issuing solid guidance on Thursday afternoon.

German enterprise software giant SAP (SAP) , meanwhile, has dropped about 7% since it slightly missed Q2 estimates and reiterated its full-year and long-term guidance on Thursday morning.

The market's reactions to Microsoft and SAP's reports arguably say something about how high expectations have gotten for many software stocks following many quarters of multiple expansion.

Heading into earnings, Microsoft's shares were up 35% in 2019, and had doubled since the spring of 2017. That had left the software giant sporting an enterprise value (EV-market cap minus net cash) equal to about 25 times its expected fiscal 2020 (ends in June 2020) free cash flow (FCF).

Though it's entirely possible that analyst FCF estimates prove conservative, Microsoft's recent multiple expansion goes a long way towards explaining why its stock is seeing only modest gains after the company comfortably beat revenue and EPS estimates, exceeded sales expectations for all three of its reporting segments, reported 22% commercial bookings growth and reiterated that it expects double-digit revenue and operating income growth in fiscal 2020. If Microsoft was trading where it was in, say, March, its stock would undoubtedly be up more strongly on Friday.

SAP was also up 35% on the year heading into its earnings -- news that activist Elliott Management had bought a stake provided a lift in April -- and had risen about 80% since the spring of 2016. This run-up had left SAP sporting an EV equal to 30 times its expected 2020 FCF.

That, in turn, helps explain why SAP has sold off so much in response to a Q2 report that was mildly disappointing, rather than truly awful. The company did slightly miss revenue and EPS estimates, while noting "trade-related uncertainty" was weighing on its Asian software sales. But it also maintained full-year guidance for cloud and software revenue -- boosted by both organic growth and the $8 billion Qualtrics acquisition -- to grow by 8.5% to 10.5% in constant currencies (CC), and for its operating profit to grow by 9.5% to 12.5% in CC.

SAP also maintained its 2020 and 2023 guidance. This includes a forecast that cloud revenue will more than triple from 2018 to 2023, and that SAP's operating margin will grow an average of one percentage point through 2023.

Looking more broadly at the enterprise software landscape, there's no shortage of growing, well-executing companies whose recent multiple expansion gives them very little margin of error. With the qualifier that analyst estimates for such companies have been frequently hiked in response to good earnings reports, here's a look at the forward EV/FCF multiples that some high-flying enterprise software firms now trade at, based on fiscal years that end between the end of 2020 and mid-2021. Forward EPS multiples, it should be noted, are generally even higher.

  • ServiceNow (NOW) : 43x
  • Workday (WDAY) : 73x
  • Atlassian (TEAM) : 49x
  • Splunk (SPLK) : 49x
  • Veeva Systems (VEEV) : 54x
  • CyberArk (CYBR) : 33x

There are also a number of growth-stage software firms that for now are producing little or no earnings and FCF, and which trade at steep forward billings multiples following big run-ups. MongoDB (MDB) , for example, now sports an EV equal to 16 times its expected fiscal 2021 (ends in Jan. 2021) billings.

In such a valuation environment, software high-flyers need to deliver earnings reports of a similar quality to the one that Microsoft just posted in order to keep their momentum going. And f, instead, they deliver a report similar to the one that SAP just posted, markets aren't likely to be forgiving.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.
TAGS: Investing | Technology |

More from Technology

Taking a Look at IBM's Technical Turnaround

Bruce Kamich
Apr 20, 2021 3:13 PM EDT

Here's where to go long.

No Longer a Boom or Bust Cyclical Stock, Micron Technology Has Found Consistency

Timothy Collins
Apr 20, 2021 2:42 PM EDT

Here's where I would consider getting long.

MicroVision's Charts Are Pointed Lower

Bruce Kamich
Apr 20, 2021 2:10 PM EDT

Avoid the long side of MVIS.

QuantumScape Charts Remain Bearish and Present New Downside Targets

Bruce Kamich
Apr 19, 2021 8:04 AM EDT

Shares of the maker of solid-state batteries point could weaken further based on its technical signals.

Netflix Reports Earnings on Tuesday: 5 Important Things to Watch

Eric Jhonsa
Apr 17, 2021 8:00 AM EDT

Along with its total subscriber adds, keep an eye on Netflix's regional growth rates, as well as its free cash flow guidance and content spending outlook.

Real Money's message boards are strictly for the open exchange of investment ideas among registered users. Any discussions or subjects off that topic or that do not promote this goal will be removed at the discretion of the site's moderators. Abusive, insensitive or threatening comments will not be tolerated and will be deleted. Thank you for your cooperation. If you have questions, please contact us here.

Email

CANCEL
SUBMIT

Email sent

Thank you, your email to has been sent successfully.

DONE

Oops!

We're sorry. There was a problem trying to send your email to .
Please contact customer support to let us know.

DONE

Please Join or Log In to Email Our Authors.

Email Real Money's Wall Street Pros for further analysis and insight

Already a Subscriber? Login

Columnist Conversation

  • 04:17 PM EDT REAL MONEY

    Wednesday on Real Money Pro

    Get-rich quick schemes offer little more than pipe...
  • 11:09 AM EDT GARY BERMAN

    S&P Futures

    FIBOCALL: The S&P futures was off 1.5 %... ...
  • 07:47 AM EDT CHRIS VERSACE

    Positive News for a Cannabis Play

    Good news for this name in the Stocks Under $10 po...
  • See More

COLUMNIST TWEETS

  • A Twitter List by realmoney
About Privacy Terms of Use

© 1996-2021 TheStreet, Inc., 225 Liberty Street, 27th Floor, New York, NY 10281

Need Help? Contact Customer Service

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data & Company fundamental data provided by FactSet. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by FactSet Digital Solutions Group.

TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

FactSet calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.

Compare Brokers

Please Join or Log In to manage and receive alerts.

Follow Real Money's Wall Street Pros to receive real-time investing alerts

Already a Subscriber? Login