We recently created a list of Jefferies’ most visited software shorts: Top 9 Stocks. In this piece, we will look at where Palantir Technologies Inc. (NYSE:PLTR) is on the list of busy software short positions.
With the end of 2024 quickly approaching, artificial intelligence continues to shape the narrative on Wall Street. The end of October marks the start of another highly anticipated earnings season, which will continue to be largely dominated by AI. On the hardware front, investors will be watching to see whether demand for AI GPUs continues and whether the market-leading company also improves its margins and profitability. For software stocks, investors will be poring over profitability data to determine whether the billions of dollars invested in AI training and testing and business partnerships are delivering results.
For software stocks, their exposure to AI is so strong that it has divided some companies’ 2024 stock performance into neat halves, determined by investor sentiment about their AI products. One of these AI software stocks is ranked 5th on our recent list of AI stocks that insiders are selling. Looking at the share price performance this year, it is fairly neatly divided into two halves that will meet on June 13th. Year to date, as of June 13, shares were down 19.8%, even though the company’s fiscal 2023 revenues were a whopping $19.4 billion and had been growing 10% annually. Before that eventful day, the company saw first-quarter revenue growth of 11% annually, but struggled to keep costs low and profit margins high.
Still, investors’ bearish attitudes toward this well-known purveyor of productivity software tools like Photoshop and Reader could change in an instant. From June 13 through the third week of October, shares changed course and rose 8.5%. Between September 13 and 12, the share had even risen 27.9%. June 13 was the day this company reported its second quarter earnings. The results led to shares rising 13% in aftermarket trading, with investors impressed by the company raising full-year guidance to a range between $21.40 billion and $21.50 billion, compared to a previous $21.30 billion and $21.50 billion.
The optimism was driven in part by the company’s Creative Cloud business, which includes products like Acrobat Pro, Photoshop and Express. The AI addition to Creative Cloud was the company’s line of generative AI models called Firefly. Management shared that Firefly was at the heart of the ARR advisory increase to $1.95 billion, as they shared:
“We are excited about the accelerating pace of innovation in the digital media industry and pleased with the adoption of AI capabilities and early monetization in Document Cloud and Creative Cloud, including our flagship applications, Firefly Services and Express. We are pleased to increase our annual net new ARR target to $1.95 billion and are excited to deliver on our rich product roadmap in the second half.”
With AI’s profitability driving Q2 earnings season, investors were naturally elated and sent the stock higher.
The June reprieve would be short-lived, however, as shares fell 13.4% in September. As usual, AI was the culprit. The downward trend began in the form of a 9.2% decline in the aftermarket following the company’s third-quarter report. The company’s fourth-quarter revenue came in at a midpoint of $5.525 billion, below the analyst consensus of $5.61 billion.
While this company is a consumer and professional software company, the broader software as a service (SaaS) industry has also not been spared by the AI-driven Wall Street trends. SaaS and software stocks are primarily valued using two metrics: the rule of 40 and EV/Sales (or variants such as EV/EBITDA or Price to Sales). These multiples are somewhat unique to the software and SaaS stock story, as they rate the companies based on their ability to grow. This is critical because one of the main reasons behind the popularity of SaaS stocks is that they don’t have to deal with inventory, logistics, or supply chain issues like other companies.
In the AI era, SaaS valuation metrics and revenue growth estimates have been severely compressed. Data shows that the average price for forwarding SaaS sales is currently 5.5x. Valuations are driven by lower growth expectations. After AI and the decimation ushered in by high interest rates, only 1% of SaaS and software companies have forward 12-month revenue growth of more than 30% as of June 2024. Digging deeper, investors have also placed a higher premium on growth While rule of 40 companies that score above 40 have a median EV/Sales multiple of 8.9x, companies with a growth rate above 30% have only a line of 40 that scores lower than 40 has a median multiple of 11.6x.
These AI-driven software shifts, driven by concerns about a decline in SaaS demand as companies develop their own software using AI, have also affected investor sentiment. According to Jefferies’ latest Trading Positioning Survey, 19% of institutional investors were overweight software stocks as of October 2024, down sharply from 28% in July and 51% in January. Still, investors have also tempered their short positions, as Jefferies shows that 54 software stocks were shorted in October, compared to 73 in July.
Our Methodology
To compile our list of the top crowded shorts in Jefferies software, we ranked the top nine crowded shorts from the latest Trading Positioning Survey by their shares short as a percentage of shares outstanding.
We also reported the number of hedge fund investors for these stocks. Why are we interested in the stocks that hedge funds invest in? The reason is simple: our research shows that we can outperform the market by imitating the best stock picks from the best hedge funds. Our quarterly newsletter strategy selects 14 small- and large-cap stocks each quarter and has returned 275% since May 2014, beating the benchmark by 150 percentage points. (see more details here).
An international stock trader intently watching the markets on a floor full of monitors.
Number of hedge fund holders in the second quarter of 2024: 44
Shares short% of outstanding: 4.36%
Palantir Technologies Inc. (NYSE:PLTR) is a data analytics software provider serving the needs of the public and private sectors. It is one of the best-known players in the national security software market, and the company has also increased its presence in the US commercial market. Commercially – and especially in today’s AI era – Palantir Technologies Inc. is benefiting. (NYSE:PLTR) for building teams that work directly with customers to assess their needs and develop specific solutions. This is important for software companies, especially in the AI era, as companies may find it difficult to tailor AI to their specific needs. Palantir Technologies Inc.’s approach (NYSE:PLTR) has also delivered, as the software company grew its commercial revenue by 70% in the second quarter. This was thanks to lucrative deals, with Palantir Technologies Inc. (NYSE:PLTR) added 96 contracts valued at more than $1 million each and 27 contracts valued at more than $10 million each.
Scout Investments listed Palantir Technologies Inc. (NYSE:PLTR) in its first-quarter 2024 investor letter. Here’s what the fund said:
“The largest contribution to returns this quarter came from Palantir Technologies. Sentiment improved against Palantir after the company reported stronger-than-expected commercial customer revenue and free cash flow. U.S. commercial growth was especially encouraging, as U.S. commercial revenue rose by a large percentage year-over-year in the fourth quarter and the number of U.S. commercial customers grew nearly as much. We expect Palantir to become one of the leading artificial intelligence (AI) software providers built on its Foundry and AIP platforms.”
In short, PLTR is in 2nd place on our list of busy software shorts according to Jefferies. While we recognize PLTR’s potential as an investment, our belief lies in the belief that some AI stocks hold greater promise for delivering higher returns in a shorter time frame. If you’re looking for an AI stock that’s more promising than PLTR but trades at less than five times earnings, check out our report on the cheapest AI stocks.
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Disclosure: None. This article was originally published on Insider monkey.
