Investors can look past GAAP losses if they are seeing cash flow and very strong top-line revenue growth. It's the revenue growth that makes investors excited. It shows the product is really selling itself to new customers.
Therefore, over the past couple of years, these SaaS companies' stock price trajectories have been remarkably straight up. There hasn't been a lot of volatility until a month ago.
Workday and another high-flier, Splunk (SPLK), went public with price-to-sales ratios around 11x. To a lot of industries, that multiple looks stretched. However, SaaS companies' revenue are so predictable and resilient that investors looked past this. At the highs at the end of February, Workday got to a price-to-sales ratio of 30x and Splunk got up to the high 20x level.
But the momentum ended. Workday got sold off 30% in this five-week pullback. Splunk was even worse, down 40% from the highs earlier this year.
Were these pullbacks deserved? Yes, at such stretch valuation levels. Are they a good buy now? They're bouncing today but I don't think they have the all-clear by any means. Decreased valuations still look pretty stretched here, despite the relative security of their future revenues.
At the time of publication the author had no position in any of the stocks mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.