StartUp / Ai Startups
Track AI startups, new venture creation, founder strategy, product direction and investment signals across the fast-moving artificial intelligence sector.
Software’s Historic Market Discount
Topic
Software Valuations and AI Impact
Key insights
- Software is exceedingly cheap right now
- Revenue multiples for post-SaaS businesses are the cheapest in 15 years
- The software sector is trading at 19 times free cash flow, a discount to the S&P 500
- The median software business is ramping to 20% margins
- Software should trade at a premium to the S&P 500 over time
- The growth rates of software businesses are twice as fast as the S&P 500
Perspectives
Discussion on software valuations and the impact of AI.
Pro-Software Valuation Premium
- Claims software is trading at historically low multiples compared to the S&P 500
- Highlights that software growth rates are significantly higher than the S&P 500
- Argues that software should trade at a premium due to higher growth and margins
- Warns that uncertainty in the market is affecting valuations
- Proposes that AI will unlock significant growth in the software market
Skeptical of AI's Impact
- Questions the sustainability of current software valuations amidst market volatility
- Denies that AI will necessarily replace existing software solutions
- Rejects the notion that cost savings from AI will lead to significant market expansion
- Accuses new entrants of potentially misallocating resources in the software market
- Highlights that customers demand proof of AIs effectiveness before committing
Neutral / Shared
- Notes that the software market is small relative to overall labor budgets
- Acknowledges the historical challenges in switching software vendors
- Mentions the volatility in post-IPO share prices as a concern for investors
Metrics
growth_rate
twice as fast as the S&P 500 times
comparison of growth rates between software businesses and the S&P 500
Higher growth rates suggest a stronger potential for future returns in the software sector.
the growth rates of these businesses are twice as fast
S&P_growth_rate
7%
growth rate of the S&P 500
Provides a benchmark for evaluating the performance of software businesses.
the S&P is growing 7%
software_spending_percentage
3%
percentage of S&P 500 companies' op-ex budget spent on software
This low percentage indicates limited investment in software relative to overall operational expenses.
the average S&P 500 company spends about like 3% of their op-ex budget on software
labor_market_size_ratio
40 times larger times
comparison of the labor market size to the software budget
This suggests a significant opportunity for AI-native businesses to capture a larger share of the labor market.
I think it's 40 times larger of the labor market
valuation
sub 10 times free cash flow times
valuation of Workday
A lower valuation multiple may indicate a more attractive investment opportunity.
we're in it sub 10 times free cash flow
growth
20% plus
growth rate of Toast
High growth rates can attract investor interest and indicate strong market demand.
compounding at 20% plus
Key entities
Timeline highlights
00:00–05:00
The current state of software valuations indicates that the sector is trading at historically low revenue multiples, particularly in comparison to the S&P 500. Growth rates for software businesses are significantly higher than those of the S&P 500, suggesting that software should eventually trade at a premium.
- Software is exceedingly cheap right now
- Revenue multiples for post-SaaS businesses are the cheapest in 15 years
- The software sector is trading at 19 times free cash flow, a discount to the S&P 500
- The median software business is ramping to 20% margins
- Software should trade at a premium to the S&P 500 over time
- The growth rates of software businesses are twice as fast as the S&P 500
05:00–10:00
The discussion revolves around the competition between established software businesses and new entrants in the market, particularly in the context of AI technology. It highlights the potential for AI to expand the software market by targeting labor costs and improving efficiency.
- There will be original businesses and SaaS businesses with deep customer relationships
- New technology leads to new entrants in the software market
- The question is who will win the incremental growth: existing software businesses or new entrants
- The software market is small, with S&P 500 companies spending about 3% of their op-ex budget on software
- AI-native businesses are targeting the labor market, aiming to replace repetitive labor
- The opportunity with AI is to expand the software market and take share from the labor market
10:00–15:00
The discussion focuses on the current state of the software IPO market, highlighting a shift from CapEx Lite to CapEx heavy models. It emphasizes the challenges investors face in evaluating unit economics and the volatility of post-IPO share prices.
- Theres been a change in the software technology ecosystem from CapEx Lite to CapEx heavy IPOs
- Investors have not been able to dig into the unit economics of new IPOs enough
- The IPO market is considered tricky due to past investor experiences
- Successful IPOs are needed for investor confidence
- Recent IPOs have shown sky high valuations that reset later
- Volatility in post IPO share prices is seen as unhealthy
15:00–20:00
Customers are skeptical about the promises of AI and are demanding tangible proof of savings. The potential savings are linked to a labor market that has been described as ten times larger than previously stated.
- The time and effort to switch is not worth it
- Customers are looking for proof of AIs excitement
- Customers want to see actual savings from AI
- The savings are expected to come at a labor market
- The labor market is described as five times bigger, but later corrected to ten times bigger