Software Stocks Crash! Buying Opportunity?

Summary

The video discusses a significant drop in software stock prices following disappointing earnings reports from Salesforce, which led to a domino effect on other companies like ServiceNow, Adobe, and Microsoft. The host differentiates between trading and investing approaches to such market events, advising traders to avoid holding positions through earnings reports to prevent significant losses. For investors, the host emphasizes evaluating the long-term quality of the business and using short-term market overreactions as opportunities to buy into fundamentally strong companies. The video provides an analysis of Salesforce's and Viva Systems' financials, arguing that despite the market's negative reaction, the underlying businesses remain robust, suggesting that the current dip could be a chance for investors to acquire more shares.

Takeaways

• 📉 Salesforce reported worse-than-expected results, causing its stock to drop over 20% on Thursday, which affected other software stocks such as ServiceNow, Adobe, Microsoft, and VIVA.
• 🧐 The distinction between a trader and an investor is crucial when reacting to stock market events like earnings reports; traders should avoid holding positions through earnings reports to prevent significant losses.
• 🤔 For investors, a significant stock drop should prompt the question of whether the drop is due to a change in the company's fundamental quality or short-term market reactions.
• 📈 Despite a bad earnings report, if a company maintains strong fundamentals and continues to grow its revenue and free cash flow, it can be considered a good long-term investment.
• 🔍 It's important to analyze the reasons behind a stock's drop to determine if it's a temporary market reaction or a sign of a deteriorating business model.
• 💰 The speaker believes that software companies like Salesforce, ServiceNow, Adobe, and VIVA are high-quality businesses with consistent growth in sales, revenue, net profit, and free cash flow.
• 📊 Only a small percentage of businesses in the market show consistent growth in revenue and free cash flow, making those that do high-quality investments.
• 📉 Market reactions can be overblown, and great companies can become temporarily undervalued, providing investors with buying opportunities.
• 🚫 The speaker advises against selling a stock solely based on short-term price movements or market reactions, unless there is a structural long-term problem with the company.
• 📈 Long-term performance of the underlying business is more important than short-term stock price fluctuations, and quality companies will likely outperform the market over time.
• 💡 The speaker suggests that the recent drop in software stocks could be an opportunity to buy more shares, especially for those who do not yet have a full position, as these companies are fundamentally strong.

Q & A

What happened to software stocks on Thursday as mentioned in the transcript?

There was a significant crash in software stocks on Thursday. Salesforce reported worse-than-expected results, causing its stock to drop over 20%. This also affected other software companies like ServiceNow and VIVA, which saw their stocks decline as well.

What was the market's reaction to Salesforce's earnings report?

Salesforce missed its revenue by 1% but beat on earnings. However, they lowered their forward guidance by 1%, which led to a market reaction where Salesforce's stock dropped over 20% on that day.

What advice does the speaker give for traders regarding earnings reports?

The speaker advises traders to never hold a trade through an earnings report because anything can happen, including significant stock price movements that could go below their stop loss.

How does the speaker differentiate between a trader's and an investor's approach to stock drops?

Traders should avoid holding positions through earnings reports, exiting before they are released to prevent significant losses. Investors, on the other hand, should focus on the long-term quality of the business and consider stock drops as opportunities to buy more if the fundamentals remain strong.

What criteria does the speaker use to judge the quality of a business?

The speaker uses criteria such as consistent growth in sales revenue, net profit, and free cash flow. They also look at gross profit margins, net profit margins, return on capital, and return on equity.

Why does the speaker believe that the drop in Salesforce's stock was an overreaction?

The speaker believes it was an overreaction because despite missing revenue by 1%, Salesforce beat earnings and saw a 43% increase in free cash flow. The forward guidance for the full year's revenue was only slightly below estimates, which the speaker does not consider a significant enough reason for such a drastic drop.

What does the speaker suggest for investors who already have a full position in a stock like Salesforce?

For investors who already have a full position, the speaker suggests holding the stock and not buying more. They can also consider selling cash-secured puts to collect extra premium.

How did the speaker's portfolio perform in the short term due to the software stock selloff?

The speaker's portfolio underperformed the market in the short term due to the software stock selloff, with a year-to-date return of 8.46% compared to the S&P 500's 11%.

What is the speaker's long-term outlook for investors holding quality software stocks?

The speaker has a positive long-term outlook, stating that if investors hold great companies, they will outperform the market over time, despite short-term volatility.

Why did the speaker buy more of a stock when it dropped in sympathy with others?

The speaker bought more when a stock dropped in sympathy because it presented an opportunity to acquire a high-quality stock at a discounted price, unrelated to the company's fundamentals.

What is the speaker's view on the importance of free cash flow for investors?

The speaker considers free cash flow the most important measure for investors, as it indicates the company's ability to generate cash that can be returned to shareholders or reinvested for growth.