Stocks of SaaS Companies Perform Worse Than Market Average – Here’s Why

The software-as-a-service (SaaS) model is one of the golden children of our modern age of technology. Thanks to a winning combination of simplicity and scalability, SaaS businesses have the potential to achieve substantial profitability and long-term growth, and thus have been favored by users, entrepreneurs, and investors alike.

However, recent data suggests that SaaS companies may be on a downward trend, from which they may or may not recover. What’s causing this, and what might it say about SaaS companies in general?

The Decline of SaaS Stocks

The stock market has been in a tumultuous state over the past six months or so. Tech stocks have been the star players in terms of overall volatility. This is nothing new, though; tech stocks, which often live or die based on trends and short-term announcements, have always been volatile picks.

But SaaS companies have stood out even from the general tech landscape. For example, the share price of Box recently dropped 12 percent and was on the verge of falling below $1 billion in market cap — a dangerous indicator for the company’s performance.

Zendesk, a popular customer service platform, faced a similarly hefty decline. Even SaaS poster boy SalesForce hit its lowest price level since 2014. Newer firms, such as Sandata, are managing to hold their own, or even grow, but the general trend has been negative … so what’s going on here?

The Weaknesses of the SaaS Model

Tech consumers have spent so much time ogling the major advantages of the SaaS model — mostly its scalability and profitability — that they’ve overlooked or forgotten some of the key weaknesses:

  • High profitability only occurs at high scales. Yes, the potential profitability of most SaaS companies is impressive, but those projected figures often depend on operations at the largest possible scale. Until they reach that point, these companies may only border on breaking even.
  • It’s notoriously difficult to build an initial user base. Once a platform reaches a certain threshold of users, it starts to become more popular based on reputation (and user referrals), but getting to that threshold initially can be terribly difficult.
  • Trendiness often drives popularity. Many SaaS platforms rise to prominence thanks to a burgeoning trend or sudden fixation. The downside to a trend-based boost is that trends are often temporary, and they can turn on you rather quickly.

These weaknesses signal several inherent problems for SaaS stock prices:

  • Investors get too excited too early. When investors see a promising SaaS company enter the market, they start drooling, and drive the prices up before the company’s even had a chance to prove itself. This is the kind of thinking that leads to the development of tech bubbles. At a minimum, it creates volatile pricing structures.
  • Anything can be seen as a warning sign. Since SaaS is still a relatively new model, and platforms exist on a somewhat volatile edge, it’s easy for any indication of subpar performance to be taken as a warning sign that the company is failing. These are often blown out of proportion.
  • Periods of volatility make SaaS companies extra vulnerable. Since SaaS companies are already volatile and dependent on user trends, any fluctuation across the market will become amplified when applied to SaaS stocks.

Conclusion and Key Takeaways

The SaaS model is theoretically appealing, but it’s more complex than most analysts would readily admit. The need for initial thresholds of user popularity, the sensationalism of a promising idea, and the desperate need for large-scale operations all put pressure on SaaS stocks that leads to increased volatility.

The recent downward trend isn’t an indication that the SaaS model is failing, or that these companies are starting to collapse. Rather, it’s a product of the inherent volatility of the model making itself known.

This isn’t a clear signal to invest more or less in these stocks, though if you’re interested in them, buying at lower prices is always a good thing. If there’s one idea to leave with, it’s that SaaS companies, though exciting and brimming with potential, are naturally more volatile than most other stocks you’re liable to find.

Try to keep that in mind when you’re investing.

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Melissa Thompson writes about a wide range of topics, revealing interesting things we didn’t know before. She is a freelance USA Today producer, and a Technorati contributor.