Stop trying to pick the bottom of the SaaSpocalypse

There’s an old saying in markets that if you try to pick bottoms, all you’re likely to end up with is smelly fingers. Vivid, I know, but it doesn’t leave any doubt about how perilous such misadventures can be.

So, it has struck me with some surprise that many investors have been trying to pick the bottom of the SaaSpocalypse rout.

Now, in writing this article, there is a reasonable chance I am ringing the bell on the selloff and setting myself up for some colourful feedback six months from now. Already, the S&P/ASX 200 Information Technology sector has taken a nice turn off the lows.

That, however, is a risk I am willing to take.

Whether couched in long-term valuation analysis, or the rougher edged ‘they’ve sold off too far’ cry from more avid punters, to me, the attempt to time the bottom is anchoring at its zenith.

Anchoring, for those who might be unfamiliar, is a nasty little behavioural finance trait in which people rely too heavily on the first piece of information they encounter (the "anchor") when making decisions.

In this case, the anchor is the price at which these stocks used to trade: “It was at $260, it’s still a great company, now it’s at $160… even if it gets back to $200, I’m doing pretty well.”

The narrative is neat and, at face value, compelling. 

Many of Australia’s software leaders have seen meaningful multiple compression, sentiment has shifted from euphoria to scepticism, and the argument follows that these are still high-quality businesses that have simply been caught in the hellfire of an AI-driven but overdone selloff, higher rates, and changing market preferences.

If that is true, then all that remains is getting the timing right. That framing, however, misses something important, because markets do not work like that - at least not reliably.

More importantly, the focus on timing the bottom assumes that price is the only variable worth considering. It assumes that these businesses will inevitably re-rate, and that the broader opportunity set has not meaningfully changed in the meantime. All three assumptions deserve to be challenged.

A more useful question, particularly in a market like this, is not whether SaaS stocks have bottomed, but why investors are so determined to return to the same group of stocks when the rest of the market is offering a wide range of credible alternatives at far less demanding valuations – but more on that later.

SaaS is cheaper, but it is not cheap

There is no doubt that valuations across the SaaS cohort have come back. What is less often acknowledged is that, even after that de-rating, these businesses continue to trade at levels that embed a significant degree of optimism.

• Pro Medicus (PME) - the current PE still sits in the 50–60x range
• WiseTech Global (WTC) remains around ~55–65x
• Xero Limited (XRO) is closer to ~50–60x
• REA Group (REA) and CAR Group (CAR) continue to command multiples in the ~25–35x range
• SEEK Limited (SEK), it's hard to establish a PE because of the earnings volatility - a story in itself

On the whole, these are not distressed valuations. They are still, by any historical or cross-sector comparison, premium. And premium pricing carries an implicit requirement. 

It demands that execution remains strong, that margins are preserved, and that competitive positioning holds, often for longer than investors might appreciate.

Growth still matters, but so does what you pay for it

None of this is to dismiss the growth credentials of these businesses.

Many of them continue to deliver earnings expansion well above the broader market, and, in some cases, they operate with margins and capital efficiency that remain genuinely impressive – for now.

The question is not whether they are good businesses. It is what is already reflected in the price.

At multiples of 50–60x earnings for many of the names, the margin for error narrows considerably. Investors are not just underwriting growth, they are implicitly assuming that execution remains consistent, that competitive advantages are maintained, and that external conditions do not materially disrupt the trajectory.

That is a high bar – particularly given the force that created the disruption in the first place: artificial intelligence.

The variable that is hardest to underwrite

The impact of AI on the SaaS ecosystem remains deeply uncertain.

I’m old enough to remember when there were no mobile phones. If I wanted to meet my friends in the city, I had to call their parents’ house phone, organise a time and a place, and then pray to God that my train (and theirs) was on time. There was no texting ‘I’ll be 15 minutes late’ – which was about the grace period on offer for teenagers with places to go and people to see.

Then, there were mobile phones as big as a brick. Then they got smaller. Then we had Snake. Then there were smartphones.

Now, the humble mobile phone has about the same computing power as a room-sized supercomputer from the early 1990s, and you can pretty much run your entire life on one – for better or worse.

Whilst that tech journey took about 30 years, from what we’ve seen so far, the AI journey is going to happen much quicker. And why wouldn’t AI companies, or some adopters of AI tech, try to compete with SaaS businesses that often have fat margins and are highly profitable? It seems to me that they would be some of the first opportunities people would go after.

Those of us who are old enough will remember the Trading Post (the old classifieds newspaper) or the property section of the Sunday paper. Both are gone the way of the dodo. The newspaper was disrupted by the internet. AI threatens to do the same thing again. At pace.

And here’s the point – it’s not slowing down, it’s speeding up. I could be wrong, but the arguments I’ve heard positing that buying beaten-down SaaS stocks is a good idea are based on a one-shot deal – that AI will pose no further problem in future and that, if there is a suitable MOAT, these businesses will be defensible. I find that a stretch – even if they do make for compelling buying right now on the numbers.

AI has the potential to lower barriers to entry, reduce the cost of building competing products, and, in some cases, commoditise functionality that was previously differentiated. If that were to occur, the implications for pricing power and margins could be meaningful.

The challenge for investors is that this is not a risk that can be neatly modelled. It is not a variable that can be dialled up or down in a spreadsheet with any real confidence.

Which raises an uncomfortable point. Investors attempting to “buy the bottom” today are, whether explicitly or not, making a call on how this plays out. 

Whichever way you cut it, that’s a high-risk bet. In the best case, it is an informed view. In many cases, it is closer to an educated guess. And in some, it may simply be a view on price rather than fundamentals.

That is a very different proposition to allocating capital to businesses where the drivers of return are more observable and, at least to some extent, more predictable. 

Great Chris, so you’ve told me the problem, what about some solutions?

Some SaaS businesses are, by any reasonable measure, still exceptional right now. They have delivered strong outcomes over time and may well continue to do so.

The point, however, is that exceptional businesses do not automatically translate into attractive investments, particularly when the starting valuation leaves little room for disappointment and when the broader opportunity set has become equally or more compelling.

The temptation to time the bottom is understandable. It offers the prospect of both validation and outsized returns.

But in a market like this, the more durable approach may be less about timing and more about discipline. And that, while less exciting, is often where the better outcomes are found.

Below, I’ve created some simple comparisons and highlighted some potential alternatives to SaaS bottom-feeding, where the earnings outcomes, and therefore the share price movements, may be more predictable. These are not recommendations, simply food for thought.

• Sonic Healthcare (SHL) around ~18-20x
• Macquarie Group (MQG) ~16–18x
• Brambles (BXB) ~18–22x
• JB Hi-Fi (JBH) ~ 18-20x
• Woolworths Group (WOW) and Coles Group (COL) in the ~18–25x range
• Telstra Group (TLS) ~16–20x
• BHP Group (BHP) ~16–18x

Over to you

Plenty of people already disagree with me; if you're one of them, feel free to tell me I'm bonkers (respectfully) in the comment section below. 

I'd love to hear the reasons why you think I'm wrong as well. Don't be shy.