My Thoughts on this Software, Data Companies Repricing – Investment Moats

I want to take this article to consolidate some of my thoughts about the recent volatility in the markets.

When Anthropic released its latest version of Claude Cowork and Claude Opus 4.6, it basically caused many sectors to go into what I would call “repricing mode”.

Markets absorb new information and tries to price the companies accordingly be it higher and lower. The challenge for you and me is to gauge if markets were being too pessimistic or that actually it’s right. It is just that Kyith have not fully comprehend how fxxked these companies are.

Then there are those who think that this is repricing is too pessimistic and that the companies will still be around. That is always a very simplistic way of looking at it. These companies such as ZoomInfo, Fastly, Teledoc are still around, but they are very very small relative to where they were at some point in 2020.

The question is how would you feel if the investments that you put money is but its 70% smaller? You would prefer them to be able to revalue back to where you bought them. That would depend on whether the industry and market dynamics we know previously is still intact.

But this time, it seems the dynamics have changed.

For those who prefer the more technical take, so that you can consider whether there is an opportunity here it is:

1. These companies that got re-rated was trading at a relatively high valuation (PE, P/FCF, P/S as proxies).
2. This means their price embeds
   • A certain competitive edge that allows them to preserve or even growth their operating margins, or that this stream of cash flow can last a long time. In valuation it means that you can assume a longer discounted cash flow model.
   • Their free cash flow is low now but their total addressable market is so much larger and they will reach a stage where their free cash flow is much higher than today. This means their current valuation values much of the value based on the future cash flows in the future.
   • Markets assign a premium or validate that a company can be more expensive because of their sturdiness and recurring cash flow. What happens when that is in doubt?
3. What was announced affect these companies the following manner:
   • They can still compete, but much of their value comes from not being a commodity company but offer value add. But now the value add is worth much less, so they become a more commodity company. They cannot charge so much for value add.
   • Instead of charging per seat, they cannot charge like that anymore.
   • What will be the new terminal margins? Margins affect profit growth and therefore affect valuations.
   • This is a variation of the ‘build versus buy’ question that their end users need to consider. Last time most of these are on-prem and then they were convinced it makes more sense to be on the cloud. How about now? Do they go back to being on-prem. [Read what Jamin Ball says]
   • On the other hand, if they can harness this AI for themselves, they can cut one of their biggest cost area, which is manpower cost. The most bureaucratic organization may stand to benefit.
   • You also need to remember that AI doesn’t mean no cost.
   • Who is faster? What happens when these SAAS companies start taking their manpower and do what these AI disrupter do?

Maybe let me add a little about the hyperscalers:

1. At some point when the interest rates in 2022 climbed 400%, those companies with a lot of debt got penalized by the market. In contrast, the Apple, Amazon, Meta, Alphabet and Microsoft were looked at the better companies because they have so much cash being able to earn such high interest. Well, for a few of these companies, the cash is no more already. If another situation comes along they lose that status.
2. Markets assign a premium to them due to their earnings growth. They are valued as growth companies despite their size whether we like it or not. They are never going to be valued as value companies or reasonable value. Markets can tolerate short term indigestion but they are going to ask for evidence of growth free cash flow eventually.
3. Markets assign a premium to these companies because of their asset-light model. They trade at so much higher than book value. But now… they are taking their cash flow, converting to assets, which means their capital base is increasing.
   • If the ROIC on this new asset is lower, their ROIC, ROA, ROE is reduced.
   • If this is one of the reasons you fall in love with these companies then you got to consider this.
   • There is empirical evidence that if you go on an asset growth spree, the stock price usually suffer. This is a factor which is part of Fama and French’s Five Factor Asset Pricing Model. In Hou, Xue and Zhang’s 2008 paper Digesting Anomalies: An Investment Approach, they found evidence that CEO’s often get overconfident, investors often get overexcited about big new projects initially, but eventual get disappointed when those projects don’t pay off, leading to stock price crash. It is further evidence why asset growth rate is one of the strongest predictors of future stock returns.

Here is one interesting chart I found on Twitter that kind of explains this Investment Factor:

The answer I feel is somewhere in the middle, but I doubt this will help you much because I didn’t tell you if you should buy or not.

How the Color in Your Eyes Change When the Price of Your Investment Change

I am not calling for it, but if the uncertainty plague these companies for 2-3 years the way it plague a stock like Adobe, I wonder how investor’s confidence about these stocks will change.

Why did I bring up Adobe?

It is because when it is so easy to generate an image, people look at them as the one that is going to die.

The thing is… their financials don’t look that bad!

Its a too short of a time period and the market is debating over Adobe’s future. But in a way, the market may be debating over a lot of these companies’ future the way they debate over Adobe’s future all this time.

People come up with their own feel good or feel bad stories behind the stories, and usually how the stocks perform affects the stories.

One of the biggest contrast is which one to own:

1. High capex, asset heavy, cyclical companies.
2. Low capex, light asset, recurring businesses.

Markets assign a premium to the latter. Adobe was there. They were on the traditional 3-year licensing model but when they pivoted to charge per seat, the valuation changed.

We were told that group 2 is the superior business because the cash flow is so much predictable, they have their economic moat, which preserve their margins, and are more scalable.

Of course they are not cheap but it is worth it to pay for them.

In contrast, save your effort on group 1 because you have to time your entry and exit because they are cyclical. If we profile the companies to buy and hold to invest, you should not invest in such firms.

But right now… the tables have turned.

1. Suddenly, there is so much demand for materials relative to supply. De-globalization may have created inefficiency such that each have to source for their own supply. Some countries need to militarize and industrialize. Suddenly, assets looked different.
2. Suddenly, the defensive moat, the high margins, looked so suspect. With a weaken moat, what do these information services firms have?

It helped that the share prices of group 1 looked so much better than group 2.

And I wonder how many are gobbling up these stocks with moats in the past right now?

All Roads Point to You Needing Systematic-Active Diversified Portfolios to Harvest Long Term Returns.

John Huber of Saber Capital was eventually right.

The reason why these quality/high profitability businesses makes good investment is because they were “cheap enough”.

And when they have grown for a while, they were “not that cheap anymore” and that reduces the margin of safety.

In contrast, more years of neglect to international, emerging markets equities of specific sectors made them “cheap enough”.

But everything requires some catalysts to trigger them to go into repricing mode.

And we have some recently with what happen after Liberation day, stimulus in China, de-globalization, the industrialization due to AI, and of course Claude Cowork and Opus.

I think many investors felt that the permanence is that software rules the world. So much so that people choose to skill up in software for their career. Until right now, they may have felt a bit fxxked by software.

What surprised many was that there can be a world where real world assets looked important again. They have always been important just overshadowed.

And at this point a question may pop in your head: Do you buy what looks good in your eyes or have confidence to focus on what worked for the past 15 years?

I learn overtime that I am pretty bad at getting this right.

I overestimate how bad office property scene can be. I underestimate how long hyperscale demand could be. I always knew that Europe and Emerging markets will do decent again but I just have no idea how would that happen.

Every event that comes along just kept showing enough of my incompetence (despite what some readers saying I am pretty sophisticated in these areas to listen a little to me).

And this is one of the critical reason why I pivot to how I set up Daedalus Income portfolio now. It is more for more stupid investors like myself. I just try my best to set it up to harvest any sector, region, factor premiums that come along.

If market cap weighted still continues to do well due to passive indexing flows, despite all the past research, I guess earning some market-beta can still allow me to achieve my income goals. But if the world becomes more uncertain with more sharp mean-reversions here and there, I kind of think such a portfolio should do decent.

I guess if there are something to be learnt it is that:

1. What is constant is humans collective became overconfident or too pessimistic.
2. What is constant is also trends can last longer or shorter than we anticipated.
3. What is constant is also the magnitude of performance.
4. Valuation ultimately will matter in the long run.
5. There are far less companies that are good companies in permanence. See 1-4 again.

If these are the major evergreen characteristics that will always be there, this might be the best way to setup our portfolio, if we want the portfolio to be passive enough.

Some Interesting Data

I think this article got way too long but I wanted to take a look at how beaten down things were, and some seemingly more fragile places and see how things were doing.

So I will leave that to maybe tomorrow.

Someone posted a list of the companies that suffered year to date from a Bloomberg terminal:

There is a bunch of software companies and data company that got wacked pretty badly.

But in honesty i was surprised with some of the names. I think valuations play a part but there were more networking and security based companies that were punished I would wonder wouldn’t they be even more relevant in the new world?

I plucked out those data based companies and their year to date drawdowns:

If you ask people about 3 years ago what will be stocks with good economic moats to buy, these companies will be the ones on the list.

But yet…. we know the stories today.

They are undergoing repricing, and it is a matter of whether what is the terminal situation. That to many is unclear (unless you are).

In a way, I just felt that its the fund management industry selling off the bunch of them that is causing this distress and in a way, I do have disagreement with where some of the prices are.

Finally, here is the new acronym (most would know how much I hate acronyms) which is HALO:

The stocks that are asset heavy that does not have so much of these problems. In fact, they might thrived in such an enivronment.

I think we should take a moment to laugh at how the world changes.

In the end price is what you pay, value is what you get.

If you like this stuff and wanna tap into my money brain, do join my Telegram channel.

I share what I come across in:

• individual stock investing
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I would also share some of the thoughts of wealth advisory, financial planning and the industry that I don’t wanna put out on the blog.

Would probably share some life planning case studies based on the things I hear or came across as well.

Kyith is the Owner and Sole Writer behind Investment Moats. Readers tune in to Investment Moats to learn and build stronger, firmer wealth foundations, how to have a Passive investment strategy, know more about investing in REITs and the nuts and bolts of Active Investing.

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Kyith worked as an IT operations engineer from 2004 to 2019. Currently, he works as a Senior Solutions Specialist in Fee-only Wealth Advisory Firm Providend. All opinions on Investment Moats are his own and does not represent the views of Providend.

You can view Kyith’s current portfolio here, which uses his Free Google Stock Portfolio Tracker.

His investment broker of choice is Interactive Brokers, which allows him to invest in securities from different exchanges all over the world, at very low commission rates, without custodian fees, near spot currency rates.

You can read more about Kyith here.