Software’s Big Comeback: Too Fast, Too Soon?
Software is roaring back, and the market is giving off strong déjà vu vibes from 2021. Over the past month, software has been the second-best performing sector, right behind regional banks, delivering nearly a 15% return. This week’s earnings from SNOW and ESTC were decent—not blockbusters—but the market went wild anyway, with both stocks finishing up more than 25% for the week. The equity market, always forward-looking, seems to be pricing in a stabilization of growth rates and a potential inflection in top-line momentum as early as mid-2025. After a period of steep growth deceleration, green shoots are visible, suggesting that software revenue growth might be turning a corner. AI-related workloads and inference appear to be the next big catalysts, as enterprises ramp up spending to capitalize on AI-driven efficiency gains. Companies tied directly to AI infrastructure have already seen massive rewards, and now the market is looking one layer up, betting on software names that stand to benefit as budgets shift toward AI integration. The sector's narrative has flipped: deceleration is out, reacceleration is in.
But here’s the problem: the market might be getting ahead of itself. Software multiples have skyrocketed in a matter of weeks, pricing in a boom that hasn’t arrived yet. Look at the numbers: DDOG jumped from 13x NTM sales at the end of September to over 17x now, SNOW from under 10x to 13x+, and NET from 15x to 18x. And it’s not just these names, across the board, valuations are surging, while consensus estimates haven’t moved nearly as much. It’s clear that the buy side is already looking deep into 2025 and betting big on these growth stories.
Opportunities in software right now? Slim. Even some of the beaten-down, acquisition-candidate plays I hold (FROG, BRZE, CFLT) have seen big moves, mostly on multiple expansion, not fundamentals. Could the rally keep going? Absolutely. Valuations don’t have a ceiling. Just like in 2021, or more recently with PLTR, multiples can keep stretching, crushing valuation shorts along the way. Something at 18x sales today could easily push 25x in this kind of environment. The key is knowing the game you’re playing. For short-term traders riding momentum and flow, these names could run further. But for long-term investors hunting for great businesses at fair prices, the software space feels picked over. Patience will be your edge here. The rally has legs, but gravity always wins eventually.
SNOW released Q3 results which sent the shares higher by 30% on the day. Product revenue showed a healthy 29% YoY growth, beating analyst estimates by 6% as the core data warehouse business showed solid growth along with contributions from new products like Snowpark. DBNR held steady at 127% a positive sign after several quarters of sequential decline. RPO reached $5.73 billion, up 55% year-over-year, marking the fourth consecutive quarter of accelerating RPO growth as they saw increase in large deal volume, including three $50 million deals in Q3. Query volume growth saw acceleration , with average daily query volume reaching 6.3 billion in October, up 75% YoY. FCF margin came in at 8% driven by bookings as 80% of customers pay annually in advance. For the FY they are projecting FCF margins of 26%, which seems a tad on the high end imo. The business exhibits some seasonality, with Q1 and Q4 typically being stronger quarters for FCF due to a higher volume of orders from new and existing customers. YTD they have repurchased $1.9 billion worth of shares while incurring just over $1B of SBC, close to 40% of revenue.
Bottom line, SNOW delivered a solid quarter, with strong commentary around Cortex AI, Snowpark, and minimal impact from Iceberg Tables on storage revenue. Given the recent negative sentiment surrounding the name, the 30% surge in the stock price might seem justified on the surface—but I think it’s overdone. The competitive landscape is intensifying. Major cloud providers are increasingly offering integrated services, aiming to retain a larger share of enterprise IT spending. At the same time, next-gen competitors like Databricks, which began as data lake specialists, are expanding into warehousing, creating comprehensive data management platforms that directly compete with Snowflake.
Then there’s valuation. Consensus projects SNOW will reach $5.4B in revenue and $1.5B in FCF by 2026, implying a 28% FCF margin. That puts today's valuation at roughly 40x '26 FCF, with poor FCF quality—largely driven by SBC, which is a real expense offset by share repurchases, deferred revenue, and favorable working capital dynamics. When factoring in dilution, the multiple balloons closer to 55x FCF. Even under a bullish scenario, where I model revenue hitting $9.1B by ‘28 (26% CAGR) and FCF growing to $2.8B with no dilution, Snowflake would still need to trade at 35x FCF in ‘28 to deliver a 10% annualized return. Achieving this scenario requires an overly optimistic business trajectory that seems unlikely in light of current competition and the company’s valuation. At today’s prices, SNOW remains expensive. Even during the pullback into the low $100s, the valuation didn’t look overly compelling, and now it’s decidedly frothy. While I wouldn’t short the stock here, I’d consider it if shares move beyond $200. For now, I have no interest in SNOW on the long or short side.
Elastic rebounded strongly in Q2, delivering a beat-and-raise quarter that exceeded expectations across revenue and profitability metrics. After stumbling in Q1 GTM execution issues, the company is beginning to demonstrate progress, supported by solid cloud consumption trends, growing AI adoption, and customer consolidation onto its platform. However, beneath the headline numbers, there are concerns about decelerating growth, muted customer additions, and valuation after the massive move post earnings.
Elastic posted $365M in revenue, up 17% YoY, exceeding consensus estimates by 3.2%. Cloud revenue led the charge with 25% YoY growth. Non-GAAP operating margins came in at 18%, smashing consensus expectations of 13% and marking the highest quarterly margin in the company’s history as some expense-reduction actions implemented in prior quarters began to materialize earlier than expected, boosting profitability. After Q1’s GTM disruptions, Elastic is seeing the benefits of its revised sales strategy, focused on enterprise and high-potential mid-market customers. Pipeline creation returned to normal levels, and customer commitments grew significantly, with three $1M+ ACV deals signed during the quarter. These improvements eased investors fears and validated management’s claims that the Q1 stumble was temporary. GenAI continues to show early signs of growth spurts as customer commitments nearly doubled QoQ, with 1,550 customers now using Elastic Cloud for AI workloads (up from 1,300 last quarter). The adoption of Elastic’s vector search technology for RAG applications continues to gain momentum, positioning the company as a key player in the AI-driven search market. Platform consolidation has been a theme for some time now and they noted that their ability to consolidate multiple use cases—search, observability, and security—onto a single platform remains a competitive advantage and over 40 competitive displacements were recorded this quarter, including wins in observability and next gen SIEM.
Elastic raised its FY25 revenue guidance to $1.46B (15% YoY growth) from $1.4B. Non-GAAP operating margin guidance also moved higher, from 12.5% to 13.5%. However, management remains cautious, pointing to Q1’s customer commitment shortfall and macro uncertainties as headwinds for H2 and thus only raised the FY guide by $1M more than they Q2 beat. Q3 revenue guidance of $367–$369M implies a deceleration to 12% YoY growth. The big news (and sight of relief) for many investors was CFO, Janesh Moorjani, announced his departure, with VP of Finance Eric Prengel stepping in as interim CFO starting December. Many long time investors (including myself) were not fans of Janesh and I believe a decent chunk of the AH move in the stock is related to his resignation. The transition will obviously introduces a layer of uncertainty. CFO changes often lead to more conservative guidance, which I think is the case for Elastic. The conservative guidance could be an attempt to ensure flexibility during this period of organizational adjustment and to align expectations with operational realities following Q1’s customer commitment shortfall.
After the post-earnings rally, ESTC now trades at a valuation north of $11 billion. With topline growth projected at 15% and 14% for FY25 and FY26 respectively, the company is priced at just over 6x FY26 sales or 38x consensus FY26 FCF. Investors pushing up the stock clearly believe the consensus is too conservative, expecting higher topline growth and stronger incremental margins as AI use cases proliferate and are adopted at scale. Margins are the critical metric to watch. For Elastic to justify this valuation and deliver attractive returns, they’ll need to sustain topline momentum and accelerate growth to an 18% CAGR through 2028, while expanding FCF margins into the low 20s. Achieving ~$600M in FCF by FY28 would require the stock to trade at just over 25x FCF in FY28 to generate double-digit annualized returns over the next few years. I previously sold $70 puts after the Q1 selloff hoping to acquire shares at cheaper levels, which will now expire worthless, but I remain uninterested in the common shares at these levels. The story is still messy, and significant execution risks remain. While the AI narrative is compelling, the margin of safety simply isn’t there to make this a worthwhile long at the current valuation.
Datadog is another popular SaaS name catching fire this week. While they reported solid earnings in early November, the stock only started taking off now. Revenue grew 26% to $690M, beating estimates of $664M. Non-GAAP operating income came in at $172M (25% margin), and free cash flow hit $204M (30% margin), exceeding expectations by $38M. A solid metric is the rising contribution from AI-native customers—now over 6% of ARR, up from 4% in Q2. They also raised full-year revenue guidance to $2.64B-$2.65B, reflecting 25% YoY growth, while maintaining a non-GAAP operating margin of ~25%.
Datadog’s strength lies in its "land and expand" strategy. Multi-product adoption is a critical metric here, signaling their evolution into a platform rather than just a product. DDOG operates one of the most efficient GTM models, leveraging product-led growth. Their focus on building user-friendly tools that deliver immediate value minimizes training and service overhead, enabling reinvestment into R&D. A significant chunk of their engineering team works on platform development, ensuring tight integration across monitoring and security features. AI is becoming a key driver for Datadog. Products like Bits AI and LLM Observability highlight their push into AI-powered solutions, which will likely fuel demand as cloud migration accelerates. Their new On-Call product integrates incident management directly into their observability platform, with strong early adoption prompting plans for broader integrations. This move could pressure competitors like PagerDuty, as customers consolidate onto platforms.
As a company, Datadog is exceptional—one I’ve owned multiple times—but the recent stock move feels stretched. At a $50B valuation on $4B in FY26 revenue estimates, the stock trades at 11x forward revenue or 45x FY26 FCF (~$1.2B). Even with a bullish case of 25%+ topline CAGRs reaching $6.8B in FY28 (well above consensus) and high-30s FCF margins delivering $2.6B in FCF, you’d still need a 30x FCF multiple to hit double-digit returns by 2028. To be fair, with $1.5B+ in annual recurring high-margin revenue growth by FY28 and low-20% topline expansion, a 30x multiple isn’t outrageous. But the stock’s rapid surge feels like a momentum trade, not fundamentals catching up. The more rational response was the range-bound trading we saw post-earnings, which allowed the business to grow into its valuation. At these levels, patience seems prudent. The run-up has been fueled by optimism and flows, but the valuation is already demanding.