Sales force (NYSE: CRM) The stock took a beating on May 30, one day after posting weak guidance for the second quarter of fiscal 2025. Salesforce and other software stocks — from Adobe to a work day, Atlantic, SnowflakeOthers are hovering around their lowest levels so far this year. The sell-off in software application and infrastructure companies, which are part of the technology sector, may come as a surprise, given… The strength of the semiconductor industry.
Here's what's driving the sell-off across software stocks, and why it's a red flag for the broader market's rally, simple Exchange-traded fund (ETF) to take into consideration if you want to buy the dip in the space.
Salesforce is slowing down
Salesforce is synonymous with growth. The SaaS company has achieved tremendous growth regardless of the market cycle. Over the past decade, Salesforce has transformed itself from a $5 billion annual revenue company to a more than $30 billion company while improving profitability by expanding margins.
Even after the recent sell-off, Salesforce is the third most valuable software company Microsoft And inspiration. So when something unexpected happens in its business, the market listens.
Salesforce reported good results and maintained revenue guidance for the full fiscal year 2025. However, it lowered its 2025 financial guidance on subscription and support revenue growth and generally accepted accounting principles (GAAP) operating margin.
Given the slowdown, analysts wondered why Salesforce didn't lower its revenue guidance and reset expectations so it could return to overpromising and overdelivering. But Salesforce seems confident it can achieve the target despite the weakness next quarter.
In the long term, Salesforce is very optimistic about the growth of artificial intelligence (AI) and its impact on its business. Salesforce CEO Marc Benioff said the following during his opening remarks on the earnings call:
But the one thing every organization needs to put AI to work is its customer data, as well as the metadata that describes the data, which provides the attributes and context that AI models need to create accurate and relevant outputs. Customer data and metadata are the new gold for these organizations, and Salesforce now manages, as I mentioned, 250 petabytes of this precious stuff. We have one of the largest and largest data and metadata repositories for front-office organizations in the world. And every day, more companies are adopting Salesforce as their front office, bringing all of their structured and unstructured data to our platform.
In short, Salesforce feels that it can use AI to run its business better and that the AI models will also rely on Salesforce tools and data – creating a win-win scenario.
This is all well and good, but the short-term challenges are stark – hence the sharp sell-off. Chief Operating Officer Brian Milham said the following during his opening remarks on the call: “We continue to see measured buying behavior similar to what we've seen over the past two years and with the exception of Q4 where we saw stronger bookings, the momentum we saw in Q4 moderated in Q1, and we saw Lengthy deal cycles, deal pressure, and high levels of budgetary scrutiny.
In other words, Salesforce says its Q4 fiscal 2024 results were a one-off and that the medium-term trend of slower growth continues. Second quarter revenue growth is expected to be only 7% to 8% compared to the same quarter last fiscal year. The nominal growth of the residual performance obligation (cRPO) is expected to be only 9%. Salesforce defines cRPO as its contract revenue that it expects to book within the next 12 months. It's basically the SaaS version of Backlog. High single-digit sales growth and cRPO indicate that Salesforce is growing at a much slower rate than in years past, which is why its full-year guidance may be at risk.
Cracks throughout the industry
Salesforce's guidance and comments on the earnings call add to the theme of slowing growth for many major software companies. Adobe sold off heavily in March when it reported weak near-term guidance. The company is investing heavily in AI and making some major product improvements, but has not been able to monetize AI meaningfully enough to offset higher expenses. Adobe's mode is very similar to Salesforce's mode. Both companies suffer from a gap between making investments in AI and seeing those investments pay off.
Workday's first-quarter 2024 earnings beat expectations, but guidance calls for slower revenue growth due to weak order backlog. The stock is now down more than 23% year to date.
Atlassian's price is down more than 30% year-to-date despite strong growth and effective cost management. Concerns about its valuation, the departure of its co-CEO, and growth in its cloud segment continue to weigh on the stock.
Snowflake's revenue has held up fairly well, but its margins and profits are full of red flags. It also has not been able to manage capital well, such as buying back its shares at a price that now appears high. The stock is down more than 25% year to date.
Finally, several major software companies are seeing a mix of growth and valuation concerns, amplified by Thursday's sell-off in Salesforce shares.
An investment institution that should be taken into consideration
With over $6 billion in net assets and an expense ratio of 0.41%, The iShares Expanded Tech Software Sector Fund (NYSEMKT:IGV) It is an excellent way to buy the dip in the software industry. The fund was created during the dot-com bubble in 2001 – giving it a long track record throughout periods of market volatility.
Microsoft, Oracle, Salesforce, Adobe, and Intuit 40.5% of the fund. Besides those larger holdings, the fund has a good balance of enterprise software companies and top cybersecurity leaders.
Some of the major cybersecurity companies e.g Crowd Strike It is hovering around all-time highs and has outperformed enterprise software companies. Broad exposure to software applications and infrastructure companies that cater to different end markets makes the fund's expense ratio well worth the price.
Despite the strength of Microsoft and Oracle, the ETF has remained roughly flat year to date — showing the extent of the sell-off in other software stocks.
Proceed with caution
Although SaaS companies benefit from recurring revenue streams, their long-term growth depends on adding new customers and expanding spending from existing customers. Innovation is a key driver of customer retention and expansion, as is the economic cycle.
Customers of these SaaS companies move across the entire economy, making SaaS companies particularly vulnerable to the ripple effects of a broader slowdown. Guidance from Salesforce and other companies suggests that customers are keeping spending tight and mindful of their costs — a topic worth monitoring for the health of the broader market rally.
The investment thesis for many of these companies has not changed, but their valuations are based on sustainable growth, so volatility may continue if there is a prolonged slowdown. Investors with a three- to five-year time horizon and a high tolerance for risk may want to consider the iShares Expanded Technology Software Sector ETF as an all-in-one way to invest in software while realizing the benefits of diversification.
Should you invest $1,000 in Salesforce now?
Before buying shares in Salesforce, consider this:
the Motley Fool stock advisor The analyst team has just defined what they think it is Top 10 stocks For investors to buy now… and Salesforce wasn't one of them. The 10 stocks that were discounted could deliver huge returns in the coming years.
Think when Nvidia I prepared this list on April 15, 2005… If you invested $1,000 at the time of our recommendation, You will have $677,040!*
Stock advisor It provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. the Stock advisor The service has More than four times The return of the S&P 500 since 2002*.
*Stock Advisor returns as of May 28, 2024
Daniel Fulber He has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Adobe, Atlassian, CrowdStrike, Intuit, Microsoft, Oracle, Salesforce, Snowflake, and Workday. The Motley Fool recommends the following options: long $395 January 2026 calls on Microsoft and short $405 January 2026 calls on Microsoft. The Motley Fool has Disclosure policy.
I prefer my ETFs to buy the dip in declining software stocks like Salesforce Originally published by The Motley Fool