Gerstner argues software stocks have reverted from premium valuations to market multiples when adjusted for stock-based compensation.
“Software stocks have reverted from a decade long superior multiple to the market to a market multiple.”
Gerstner explains software stocks fall before earnings miss due to higher discount rates and lower terminal values.
“We can't forecast as well. Therefore, the terminal value must be lower. The discount rate is higher and the multiple comes down. So the stocks come down well before they start missing.”
Gerstner explains software stocks previously traded at 35x free cash flow due to bond-like predictability.
“Give them 35 times free cash flow because I had that level of predictability. It was like a government bond.”
Gerstner says AI uncertainty has rationally caused investors to discount future cash flows and terminal values.
“I can't see as far into the future, so I'm gonna pay less for the terminal value. I'm gonna pay less for those future free cash flows.”
Gerstner says software multiples fell from 17x forward revenue in 2021 to 4.2x today, a generational low.
“Look at that peak in 2021. Right? We're almost 17 times forward revenue. Today, we're at at about 4.2 times. So we're at a generational low in terms of the the multiple for software.”
Gerstner says software multiples fell from 17x forward revenue in 2021 to 4.2x today, a generational low.
“We're almost 17 times forward revenue. Today, we're at at about 4.2 times. So we're at a generational low in terms of the the multiple for software.”
Gerstner explains that rule of 40 and revenue multiples are shortcuts for determining free cash flow multiples.
“Whether your rule of 40 or a multiple of revenue, those are shorthands for getting at the multiple of free cash flow.”
Gerstner found only 21 public software companies exceed $2B revenue and $25B value.
“Public software companies over 2,000,000,000 in revenue, we got to 21. Okay? There are only 21 that are worth more than $25,000,000,000”