Chapter 1: Why are software stocks down amid AI concerns?
Making sense of the situation in SaaS stocks. This is Motley Fool Money. Tyler Crowe Welcome to Motley Fool Money. I'm Tyler Crowe. Today, I'm joined by longtime Fool contributors Matt Frankel and John Quast. A few of us are going to be at a Motley Fool member event and we'll be a little bit of traveling, so we're pre-recording this episode.
But we're going to do a special episode where we're going to answer a listener question that we realized we couldn't do in a single segment, and we wanted to do a whole show about it. It's, of course, about SaaS companies or software as a service. We got a question a couple days ago from Scott Pounders, one of our listeners.
He asks, I own quite a few SaaS companies in my portfolio, SaaS meaning software as a service, that have been hit hard due to the AI revolution. Some have seen obvious that they can survive with AI. Could we do an episode which in which popular SaaS companies are most vulnerable to AI. I'm looking at particular companies, HubSpot and Constellation Software.
Before we get too deep, I want to set the stage here of SaaS companies, why Scott is so anxious about this particular topic. I don't want to assume everyone listening knows exactly what's going on with SaaS companies and the disruption that we're seeing with AI. John, how about you set the stage here for what Scott is asking for everyone else?
Yeah, absolutely. I want to speak to that, Tyler. First, I do want to speak to SaaS companies in general and why investors have really loved these stocks historically. I think there are two reasons why these have been well-loved. They're just really good businesses. The first way that we see that is, these companies offer a software product suite.
This means that usually these companies have high profit margins. If it can get a customer It can then start selling these bolt-on software products with very little incremental effort. That just boosts the revenue. Much of it drops straight to the bottom line. Very attractive financials, generally speaking, in the SaaS industry.
The second thing is that these companies usually have a recurring revenue model. Once you get a customer, they buy from you basically every month. That's very different than, say, Whirlpool. Whirlpool might sell you a washing machine, and you might love that washing machine, but you're not going to buy another washing machine next month. It's going to be a long time.
Whirlpool is doing a one-time sale and done kind of a business. A SaaS business, it's a recurring revenue model. That's a great thing to have. High margin, recurring revenue. Here's the problem. They could be disrupted by artificial intelligence. A couple of skilled AI prompters can create software products that do what some of these SaaS companies do, and they can do it in just a matter of days.
Investors are understandably scared about this. We can look at the sentiment with an exchange-traded fund called the iShares Expanded Tech Software Sector ETF. ticker symbol IGV.
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Chapter 2: Which SaaS companies are most vulnerable to AI disruption?
This ETF owns a lot of SaaS stocks. Over the last six months, it's dropped over 30%, whereas the Nasdaq is only down about 9%. That shows us directionally, investors are running away from SaaS companies.
As we kind of look about this, as you said, it's starting to show up in companies, like you said, in this ETF. And for a lot of the part, it's happening mostly on valuation. We haven't really seen a whole lot of... I would say like... tangible evidence of it across the entire SaaS universe. But there are some isolated examples.
And Matt, maybe you could walk through maybe some of the core examples of companies that actually have been disrupted by AI so far.
The online homework, help, and tutoring platform Chegg is probably the most extreme example of this so far. The stock is down by 99%, not even misspeaking, down by more than 99% since peaking in 2021. Essentially, free AI tools that are available, like ChatGPT, have literally replaced its core product. Even Google, since it chose AI right in search results, it's done that.
Revenue is falling by 40% year-over-year right now. Traffic from its users is dropping even faster. But with most of the stocks that we're covering, including the two that were mentioned by the listener, that have been beaten down, nothing has really happened yet except investor fears.
It's estimated that more than $2 trillion in market cap has been wiped out by SaaS businesses in the first quarter of 2026 alone. But some of the most vulnerable businesses that we'll get into in a minute are still seeing revenue climb and more businesses adopt their platforms. For example, ServiceNow stock has dropped over 50%.
over the past year, despite growing subscription revenue by more than 20%. Datadog is down nearly 40% from its high. Booking surged by 37% year-over-year in the latest quarter. Adobe is another one that's trading for roughly one-third of its historic price to earnings valuation. Now, I'm not saying that these companies aren't going to be impacted by AI.
But in a lot of cases, so far, there's a disconnect between the stock performance and the actual business results we're seeing from the company.
Let me go in a little bit of a scenario planning situation for investors, and I'll direct this back to you, Matt. Spelling out the best-case, worst-case scenario here, as you're looking at the space, what is the doom and gloom scenario for SaaS companies, and what is the Pollyanna, hey, this is probably good for us sort of situation?
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Chapter 3: What factors make SaaS companies attractive to investors?
He said he believes that AI agents won't replace enterprise software, but the agents themselves will use the tools. Specifically called out ServiceNow, Cadence, Synopsys. But his logic could apply to most of the SaaS companies we're talking about, not Chegg, obviously.
Yeah. Unfortunately, I think Chegg might end up being the punching bag that we talk about the most today when it comes to this topic. After the break, we're going to talk about some of the ones that we don't think are in much trouble. We'll also get into some of the ones that we really think are in trouble.
But before we do, I really want to make sure that we get Scott's question answered here, because he was specifically asking about HubSpot and Constellation. John, Running the gamut of SaaS companies today, where do you see HubSpot and Constellation landing on that spectrum of, hey, it'll be okay versus these companies are absolutely doomed?
The truthful answer is, I don't know. You look at a business like HubSpot, you look at something like Constellation Software. HubSpot, this is the customer retention management platform, marketing, sales, all that kind of stuff. You can make a very good case that AI can do this well. The same thing with Constellation.
It owns so many different software products that it's logical that at least some of them can be replicated with good AI coding. I understand the fears when it comes to those two businesses. I would understand if an investor would take an outside look and be like, I'm a little bit nervous here. Again, though, I will circle back to something that Matt did say.
There's a case where Chegg is already seeing the disruption, but there are many businesses, and these two are included, where it's fear, but AI is not eating the lunch yet. Both of these companies, you look at their trailing 12-month revenue, both are at all-time highs. You look at free cash flow, both of these companies are at all-time highs.
The only thing that has changed so far for Constellation and HubSpot is the valuation. Right now, Constellation trades at three-time sales. It hasn't been this cheap since the great financial crisis. HubSpot wasn't around back at the great financial crisis. It actually trades at its lowest valuation ever since going public at four times sales. It has had a huge reversal in the valuation.
Remember what I said at the outset. These are great businesses, great margins. They enjoyed very high, elevated valuations. Now, investors are like, there's no future here. They've gone completely the opposite direction. Maybe the pendulum has swung. If investors are right, Right now, investors are saying that Constellation and HubSpot don't have a future.
If investors are right, then we will see that show up in the financials, and it's only a matter of time. But if investors are wrong here, these two SaaS companies, if they can thrive in the age of AI, then this is a fantastic contrarian opportunity here. But it really depends on how you see it specifically for these two. I don't know personally, so I would stay on the sidelines personally.
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Chapter 4: How is investor sentiment affecting SaaS stock valuations?
Just our one request is always keep it foolish. That email again is podcasts at fool.com, podcasts at fool.com. We're going to go around the horn again. Instead of looking at what we say the highest likely victim of being in the AI world, I want to think of the survivors.
What are the companies that you think, based on their current business models, are, I wouldn't say set up to thrive necessarily, but set up to weather the storm relatively well in the world of AI?
I would say Thrive for a couple of them. I'm not sure how popular this opinion is right now. But I do think that the cloud-based cybersecurity companies, specifically Zscaler and CrowdStrike, ticker symbols are ZS and CRWD, are set up to thrive in an agentic AI world.
It's not as much of a threat to these businesses as it is a tailwind, and it's being perceived as a threat to both of these just based on their stock performance. For one thing, the global cybersecurity market is expected to roughly triple over the next seven years.
Although AI is widely expected to do a lot of the things that these platforms do, like identify bugs in software and threats that we already know about, it also can create new threats that will need to be dealt with. Malicious prompts are being inserted into LLMs right now. Magentic AI will be able to create its own malware. It can do it quicker than threats were being developed before.
An AI-native solution like CrowdStrike, in particular, is in an excellent position here. So is the zero-trust access that Zscaler provides. It's going to be so much more important to its enterprise clients than ever. CrowdStrike's management is even called AI the largest opportunity in cybersecurity yet. And the company's revenue growth is expected to accelerate this year.
Zscaler is in a similar position. Management has quantified this by estimating that securing agentic AI operations is a $19 billion untapped market opportunity just by itself, not including whatever else they do. With both companies, there's also the trust factor. People trust these companies. The majority of the S&P 500 uses these two platforms.
Assuming that both companies are able to keep up with the ever-evolving landscape of threats, they're in a great position to keep growing. Zscaler and CrowdStrike, they're down by 60% and 30%, respectively, from their recent highs. I think this is a massive overreaction by the market.
First, I want to go on record and agree with Matt. Second, I almost went safe here with my idea. I almost went really safe. I think Autodesk may be one that is really safe. I don't see construction workers really changing gears altogether in the world of AI. I think that they stick with the CAD software.
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Chapter 5: What are some examples of SaaS companies impacted by AI?
First of all, if you're an app developer and you do that, Why would people start using your app over the Duolingo app? A few things we have to consider here. There's branding with Duolingo. There's also a network effect with other users. So your new app doesn't have that. And usually speaking, your new product has to be an order of magnitude better to get people to switch.
It can't be just as good. It needs to be even better. So I don't know if an app developer is going to do that. And then a user... Why would I, as a language learner, create my own language learning app when Duolingo is already free to use? It just doesn't make sense to me. If you look at what has happened to Duolingo over the past year, it's gone from trading at 32X sales to 4X sales.
From very optimistic investors to very despondent. In fairness, management did come out and say, listen, we're going to focus on the free tier here in the coming years. They have a paid tier, a free tier. As a result, they're expecting lower bookings growth in 2026. There is that. There is that. Now, from management's perspective, it's just because they're focusing on the free tier.
Naturally, that does lead to lower bookings. They want to improve that user experience. It's still forecasting credible three-year growth. Maybe it's all management smoke and mirrors. That does happen in publicly traded companies. But I think that this company is far more resilient than investors are giving it credit for. I think what it's doing is reasonable.
I don't think AI is going to replace it. I know that's a controversial take. But hey, I like to keep it a little bit spicy.
I was going to jump in with my concluding thoughts on what I thought was, but something as controversial as Duolingo as the AI survivor, I can't top it. I'm just going to bow out and say that this is all the time we have for today.
As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only.
To see our advertising disclosure, please check out our show notes. Thanks for producer Dan Boyd and the rest of the Motley Fool team. For Matt, John, and myself, thanks for listening, and we'll chat again soon.
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