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Workday Inc. (WDAY) Faces Volatility Amid Economic Challenges

We recently published a list of Jefferies’ Top Crowded Software Long Positions: Top 10 Stocks. In this article, we are going to take a look at where Workday Inc. (NYSE:WDAY) stands against other Jefferies’ top crowded software long positions’ stocks.

After the post-pandemic rush and the subsequent inflation and glut-driven crash experienced by technology stocks, the sector is now fully bathing in the tailwinds and headwinds generated by artificial intelligence. Yet, unlike the pandemic, inflation, and interest rate-driven effects, AI has grown the addressable market for technology companies and shaken up several of them as well.

Within technology, one sector that has been shaken by AI is the software industry. Before AI, software firms were content with generating stable subscription-driven recurring revenue, but with AI, investors are not only focused on their ability to deliver AI products and monetize them but also on the fact that the firms themselves might be made redundant because of the new technology.

Nowhere else is the latter effect clearer than on software as a service (SaaS) stocks. These stocks offer software products on a subscription basis, and their narrative is based on their ability to deliver technologically complex products that businesses are unwilling to develop because of costs. The impact that AI has made on the SaaS sector is driven by the opinion that as AI enables users to easily create their software, several SaaS companies might not be needed in the business world.

To understand how AI has impacted software stocks, consider data from hedge fund Coatue Management. It shows that booming AI interest has led to software stocks taking the back seat as semiconductor stocks bask in investor attention. During the SaaS peak of 2022, the difference between the returns offered by a SaaS stock index and the semiconductor index were at their highest for the past decade. But, as of June 2024, the difference between the semi and the SaaS index is at the highest for the past decade in a 180-degree paradigm shift driven by AI.

These returns have also been driven by the beefy margins delivered by the semiconductor firms. Margins are a key valuation driver of SaaS stocks, and one popular valuation tool among investors is the Rule of 40. This rule sums up a SaaS stock’s revenue growth rate and profit or operating margin and checks whether the new value is greater than 40. As a result, margins play a key role in SaaS valuation, as a 40% or higher margin means that the firm can get away with little to no growth.

Why is 40% important? Well, according to Coatue, as of June 2024, Wall Street’s top AI GPU stock pick and the stock that ranked 6th in our list of the 10 Most Profitable Stocks of the Last 10 Years had operating margins of 65% and 49%, respectively. On the flip side, the largest software company in the world known for its Windows operating system had a margin of 44%. For chip stocks, new products drive margins since they can charge a premium through high prices. Whether these margins are sustained is another matter, and it was also part of the reason that the GPU firms’ shares fell by 6% as its full-year margin gross guidance of mid-70 % fell short of analyst expectations of 76.4%.

Coming back to software stocks, another metric used in their valuation is the price-to-sales ratio since several software and SaaS firms are unprofitable. In the era of AI, the SaaS index quoted by Coatue is trading at 5.5x price to forward sales. This is well below the long-term median of 7.2x and just a quarter of the 2021 peak of roughly 22x. This valuation compression is accompanied by lower revenue growth estimates. As mentioned above, growth is a fundamental tenet of SaaS and software valuation, and as of June 2024, just one percent of software companies had a next twelve-month revenue growth rate greater than 30%. At the peak of the software boom, 30% of firms faced similar expectations. Digging deeper, several factors are driving this trend.

AI is affecting SaaS stocks by making them shift to a consumption-driven model that charges customers for the services used instead of seat-based packages that simply sell capacity. Additionally, software stocks are also reckoning with the fact that their customers might end up using AI to cost-effectively develop their software instead of relying on expensive third-party options. As Jensen Huang shared in a 2021 interview with Time Magazine, well before his firm’s stock posted 1,100% in share price gains:

“AI is a watershed moment for the world. Humans’ fundamental technology is intelligence. We’re in the process of automating intelligence so that we can augment ours. The thing that’s really cool is that AI is software that writes itself, and it writes software that no humans can. It’s incredibly complex. And we can automate intelligence to operate at the speed of light, and because of computers, we can automate intelligence and scale it out globally instantaneously. Every single one of the large industries will be revolutionized because of it. When you talk about the smartphone, it completely revolutionized the phone industry. We’re about to see the same thing happen to agriculture, to food production, to health care, to manufacturing, to logistics, to customer care, to transportation. These industries that I just mentioned are so complex that no humans could write the software to improve it. But finally we have this piece of this new technology called artificial intelligence that can write that complex software so that we can automate it. The whole goal of writing software is to automate something. We’re in this new world where, over the next 10 years, we’re going to see the automation of automation.”

So, as the software industry undergoes a once-in-a-generation shift, it’s important to see how institutional investors are positioning their trades. Its latest survey is historic as it shows that just 19% of institutional investors are overweight in software stocks, the lowest reading recorded since the survey started. The figure sat at 51% in January and dropped to 28% in July. Yet, even though investors are less overweight, they’ve also reduced their short exposure as they’ve shorted 54 software stocks as of October 11th – down from 73 in July. So, let’s take a look at the stocks that they persist to be long in.

Our Methodology

To make our list of Jefferies’ top overcrowded software long positions, we ranked the top ten crowded long positions from the latest Trading Positioning Survey by their shares short as a percentage of outstanding shares.

For these stocks, we also mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points. (see more details here).

A group of finance professionals analyzing market trends on their computer screens.

Workday Inc. (NYSE:WDAY)

Number of Hedge Fund Holders In Q2 2024: 86

Shares Short % Of Outstanding: 1.75%

Workday Inc. (NYSE:WDAY) is a human operations and financial management software as a service provider. With the broader business spending and operating environment still struggling from the Federal Reserve’s 24-year high interest rate cycle and inflationary trends, the firm has felt the pinch as its shares are down 9.14% year to date. Workday Inc. (NYSE:WDAY) prospers when businesses are hiring and when firms have ample money in their budget to invest in process software, and it has struggled in today’s high inflation era. During the firm’s fiscal years 2021 to 2023, it struggled to keep costs under control and ended up posting operating losses in each of the years. This was even though for each year, Workday Inc. (NYSE:WDAY) also grew revenue by roughly $1 billion. The slow labor market has also injected considerable volatility into its shares. For instance, the stock fell by 15% in May after Workday Inc.’s (NYSE:WDAY) fiscal first quarter SEC filing warned that moderating business spending could create future headwinds. Yet, the shares jumped by 12.5% in August after the Q2 report saw Workday Inc. (NYSE:WDAY) beat analyst EPS and revenue estimates of $1.65 and $2.071 billion by posting $2.085 billion revenue and $1.75 in EPS and increase its 2027 margin guidance by five percentage points to 30%.

Parnassus Investments mentioned Workday Inc. (NYSE:WDAY) in its Q2 2024 investor letter. Here is what the fund said:

Workday, Inc. (NASDAQ:WDAY), a provider of human capital and financial management software, warned of slower growth in subscription revenue even as first-quarter revenue and earnings topped expectations. We added to our position as it fell to a valuation that we believe does not reflect its revenue growth and increasing operating margins.”

Overall, WDAY ranks 5th on our list of Jefferies’ top crowded software long positions’ stocks. While we acknowledge the potential of WDAY as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than WDAY but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

READ NEXT: 8 Best Wide Moat Stocks to Buy Now and 30 Most Important AI Stocks According to BlackRock.

Disclosure: None. This article is originally published at Insider Monkey.

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