After a list of downgrades, citing excessive valuations, being issued by JPMorgan analysts, Adobe’s and Cloudflare stocks experienced the worst day of the year as shares of other cloud software companies plummeted.
JPMorgan analysts Jackson Ader and Sterling Auty reduced their recommendations on 13 firms in a 2022 outlook report on software technology while upgrading only five.
A mix of limited upside compared to price estimates, valuation with the possibility that interest rates are going to rise at the beginning of 2022, revising discounted rates with the present rate, and re-evaluating realistic cash flow assumptions are the reasons for the downgrades.
Higher interest rates have a disproportionately negative impact on high-multiple tech businesses as they end up cutting into the future flow of cash predictions, which is a critical criterion to check the value of growth stocks.
With interest rates rising, multiple highly-rated software stocks which are trading at over 20 times sales are becoming riskier. According to FactSet, Adobe is valued at 21 times high. Adobe shares were also over 31% this year before Tuesday’s 6.6 percent drop, outperforming the S&P 500’s 20% gain. The stock rose to $658.30, narrowly missing JPMorgan’s $680 price objective, prompting the bank to downgrade its recommendation from buy to neutral.
In 2021, Adobe was one of the stronger performers, particularly when it was in a large-cap category, and the improved economic situation following the pandemic encouraged enterprises to invest in digital marketing solutions boosting top revenue. Analysts downgraded the stock into a neutral rating because it’s currently less than 10% away from the expected price.
Following the release of the research on Tuesday, shares of the major Cybersecurity companies, including Zscaler and Cloudflare, fell 7.8 percent and 9 percent, respectively. Prior to Tuesday, Zscaler was up 55 percent and had a 39 enterprise value to sales multiple for 2022. Cloudflare is up by 91%, trading at a 61-times multiple.
Since it is pushing itself as a part of the fourth cloud just behind Microsoft, Amazon, and Google, JPMorgan believes Cloudflare will end up as the top revenue source in its covered universe within 10 to 15 years.
Following a similar downgrading by JPMorgan, Datadog’s stock fell 6.5 percent on Tuesday. The decision to downgrade the company is “purely a value call.”