Will AI Destroy the Software Industry?
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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.
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.
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Chapters
5 chapters
1
Why are software stocks down amid AI concerns?
0:05–3:32
2
Which SaaS companies are most vulnerable to AI disruption?
3:32–7:14
3
What factors make SaaS companies attractive to investors?
7:14–18:57
4
How is investor sentiment affecting SaaS stock valuations?
18:57–22:28
5
What are some examples of SaaS companies impacted by AI?
22:28–24:50