Why software leaders ServiceNow, Snowflake and UiPath are successful today

Software leaders ServiceNow (NYSE:NOW), Snowflake (NYSE: SNOW)AND UiPath (NYSE: PATH) rose on Friday, rising 3.1%, 3.7% and 4.4%, respectively, in intraday trading.

There was no news today regarding these three enterprise software leaders. However, today’s solid jobs report, coupled with continued dovish comments from Federal Reserve officials, sent all stocks skyrocketing.

Software stocks will benefit from a soft landing

The last few years of rising interest rates have been difficult for software companies in general. While ServiceNow has impressively managed to buck the trend and recover significantly from the downturn in 2022, Snowflake and UiPath continue to see declines of 62% and 76%, respectively, over the past three years.

NOW data by YCharts

Interest rates had a lot to do with this. When post-pandemic inflation gathered pace and the Federal Reserve raised interest rates, it hit software stocks in many ways.

First, rapidly rising interest rates have caused companies to pull back on software spending for fear of a downturn, especially as software has seen massive adoption during the pandemic. Second, rising interest rates also disproportionately hurt software stock valuations, as software stocks tended to trade at very high earnings or sales multiples. Rising rates reduce the present value of earnings in the distant future, which hurts many stocks like software. As a result, software stocks have been hit with a “double whammy” of slowing growth and sharply reduced valuations.

What could reverse this trend? Well, a “soft landing” where inflation and interest rates fall without a recession would be the ideal scenario. Greater trust and employment could drive more software subscriptions or, in the case of Snowflake’s pay-as-you-go model, greater use of computing power. Meanwhile, lower interest rates will push up valuations.

Inflation has been falling recently, prompting the Federal Reserve to lower the federal funds rate by 50 basis points last month on September 18. While some thought lower inflation could go hand in hand with an economic slowdown, today’s September jobs report missed expectations, adding 254,000 jobs, well above the forecast of 150,000 and compared to the revised 159,000 jobs added in August.

Solid job growth and lower interest rates are an ideal environment for stocks in general, but especially for the price-sensitive software sector.

Of course, the hot jobs report could mean that inflation may not be subdued yet and could keep rates high. But Federal Reserve Governor Austan Goolsbee shows up in Bloomberg Television said today that the good employment report does not mean an increase in inflation. He still sees inflation returning to the Fed’s 2% target and has pledged no change in the outlook for further rate cuts over the next 12 to 18 months.

Next software problem: AI interference

While the interest rate and economic situation for software stocks looks great right now, there are still a few things to consider. First, while interest rates are likely to return to “neutral” levels soon, they are unlikely to return to their pandemic-era lows. Therefore, we should not expect software companies to repeat the inflated valuations of 2020 and 2021.

Moreover, the AI ​​revolution could benefit or disrupt some software companies. ServiceNow does quite well because it is a combination of on-premises private data and external cloud, so it can serve as an enterprise AI manager while also enabling external LLM. Interestingly, UiPath and Snowflake are more cloud-based, and while they are seeing growth, they are not benefiting as much from AI – at least not yet.

So while the interest rate picture is getting better for software, investors will have to choose which stocks will have AI as an added value and which may face increased competition from the AI ​​revolution.

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Billy Duberstein and/or his clients have no position in any of the stocks mentioned. The Motley Fool covers and recommends ServiceNow, Snowflake, and UiPath. The Motley Fool has a disclosure policy.