Morgan Housel once observed stock prices are a number today multiplied by a story about tomorrow. For years Software as a Service (SaaS) companies reported compelling numbers on their quarterly earnings calls. Software companies have long been the darlings of Silicon Valley and Wall Street because of their nearly zero marginal costs. Pre-internet, most businesses were constrained by high marginal costs. Henry Ford revolutionized mass production of the automobile, but each additional car produced incurred a high level of marginal cost. Steel, other materials, the employees on the assembly line, health insurance and payroll taxes for those employees, etc. High marginal costs put a ceiling on profit margins. Then the internet showed up and businesses began selling software (SaaS). Marginal cost = $0. Microsoft can ship out the next package of Microsoft Office to a customer for a cost of $0. The additional revenue drops straight to the bottom line. The CEOs in San Francisco are far wealthier than those in Detroit.
The story of infinite demand and zero marginal costs for SaaS companies is compelling. Investors reaped the rewards, particularly post Great Financial Crisis. Artificial intelligence’s advent in the fourth quarter of 2022 buoyed the story. AI is a massive upsell opportunity for software companies. Microsoft (or insert any SaaS company) already has an entrenched massive user base, now they can upsell CoPilot (or insert any SaaS company’s AI plug-in) at zero marginal cost. SaaS stocks soared.
Then the story changed.
AI will replace the need for software altogether.
Who needs to pay SalesForce for an enterprise subscription when someone with no coding background can use Claude Code to build a customized CRM for their business in a few hours? Why buy a HubSpot seat for the twenty members of your marketing team when two members augmented by a suite of AI agents can produce the same output? Why pay ServiceNow to redline legal contracts when Anthropic’s AI agents can redline and rewrite the contracts at a fraction of the cost?*
The story changed in January. Here is the S&P 500 (blue line) compared to the SaaS sector ETF (red line) over the last year. See if you can spot when the story changed:
It started in Q4 last year and then the SaaSpocalypse kicked into high gear in January. As of this writing, Salesforce is down 48% from its all-time high despite earnings per share increasing over 11% from last quarter. ServiceNow’s stock price is down 58% from its highs. Zoom – the company providing the software you almost surely will use at your office today – is down 84% from its all-time high. Look under the hood of the SaaS sector and you’ll find a lot of companies growing earnings while their stock prices get shelled.
2026 has already offered a wonderful illustration of the perils of constructing portfolios based on stories. They change on a dime. Investors receive no advance warning.
Sean Cawley, CFP®
*The jury is still out regarding whether LLMs will replace many SaaS offerings. No one knows the future. But it’s a SaaSpocalypse for now.
Source: YCharts
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