Salesforce (CRM 1.68%) stock got clobbered on May 30, a day after posting weak second-quarter fiscal 2025 guidance. Salesforce and other top software stocks -- from Adobe to Workday, Atlassian, Snowflake, and others are hovering around their lowest levels so far this year. The sell-off in software application and infrastructure companies, which are a part of the tech sector, may come as a surprise, given the strength of the semiconductor industry.
Here's what's driving the sell-off across software stocks, why it presents a red flag for the broader market rally, and a simple exchange-traded fund (ETF) to consider if you want to buy the dip in the space.
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Salesforce is slowing down
Salesforce is synonymous with growth. The software-as-a-service (SaaS) company delivered breakneck growth no matter the market cycle. Over the last decade, Salesforce transformed itself from a $5 billion annual revenue business to over $30 billion while improving profitability by expanding margins.
CRM Revenue (TTM) data by YCharts
Even after the recent sell-off, Salesforce is the third-most valuable software company behind Microsoft and Oracle. So when something unexpected happens in its business, the market listens.
Salesforce reported good results and maintained its full-year fiscal 2025 revenue guidance. However, it lowered its fiscal 2025 guidance on subscription and support revenue growth and generally accepted accounting principles (GAAP) operating margin.
Given the slowdown, analysts wondered why Salesforce didn't just cut its revenue guidance and reset expectations so it could get back to underpromising and overdelivering. But Salesforce seemed confident it could still hit the mark despite the weak upcoming quarter.
In the long term, Salesforce is extremely optimistic about the growth of artificial intelligence (AI) and its impact on its business. Salesforce CEO Marc Benioff said the following during his opening remarks on the earnings call:
But the one thing that every enterprise needs to make AI work is their customer data, as well as the metadata that describes the data, which provides the attributes and context the AI models need to generate accurate, relevant output. And customer data and metadata are the new gold for these enterprises, and Salesforce now manages, as I mentioned, 250 petabytes of this precious material. We have one of the most and largest repositories of front-office enterprise data and metadata in the world. And every day, more companies are adopting Salesforce as their front office, bringing all their structured and unstructured data into our platform.
In short, Salesforce feels that it can use AI to run its business better and that AI models will also depend on Salesforce tools and data -- resulting in a win-win scenario.
That's all well and good, but the short-term challenges are glaring -- hence the sharp sell-off. Chief Operating Officer Brian Millham said the following during his opening remarks on the call: "We continue to see the measured buying behavior similar to what we experienced over the past two years and with the exception of Q4 where we saw stronger bookings, the momentum we saw on Q4 moderated in Q1. And we saw elongated deal cycles, deal compression, and high levels of budget scrutiny."
In other words, Salesforce is saying that its fourth-quarter fiscal 2024 results were a one-off and that the medium-term trend of sluggish growth persists. Second-quarter revenue growth is expected to be just 7% to 8% above the same quarter last fiscal year. And nominal current remaining performance obligation (cRPO) growth is expected to be just 9%. Salesforce defines cRPO as its revenue under contract that is expected to be booked within the next 12 months. It's basically the SaaS version of a backlog. High-single-digit sales growth and cRPO suggest Salesforce is growing at a far slower rate than in years past, which is why its full-year guidance could be in jeopardy.
Cracks throughout the industry
Salesforce's guidance and commentary on the earnings call add to the theme of slowing growth for many top software companies. Adobe sold off big-time in March when it reported weak near-term guidance. The company is investing heavily in AI and is achieving some major product improvements, but it hasn't been able to monetize AI meaningfully enough to offset higher expenses. Adobe's situation is very similar to Salesforce's. Both companies are experiencing a lag between making AI investments and seeing those investments pay off.
Workday's first-quarter 2024 earnings beat expectations, but guidance calls for slowing revenue growth due to a weak order backlog. The stock is now down over 23% year to date.
Atlassian is down over 30% year to date despite strong growth and effective cost management. Concerns over its valuation, the departure of its co-CEO, and growth in its cloud segment continue to pressure the stock.
Snowflake's revenue has held up fairly well, but its margins and earnings are chock-full of red flags. It also hasn't managed capital well, such as buying back its stock at what now looks to be a high price. The stock is down over 25% year to date.
All told, many top software companies are experiencing a combination of growth and valuation concerns, which were amplified by Thursday's sell-off in Salesforce stock.
An ETF to consider
With over $6 billion in net assets and an expense ratio of 0.41%, The iShares Expanded Tech-Software Sector ETF (IGV 0.51%) is an excellent way to buy the dip across the software industry. The fund was created during the crucible of the dot-com bust in 2001 -- giving it a long track record throughout periods of market volatility.
Microsoft, Oracle, Salesforce, Adobe, and Intuit comprise 40.5% of the fund. Besides those top holdings, the fund is well balanced across enterprise software companies and top cybersecurity leaders.
Some top cybersecurity companies like CrowdStrike are hovering around all-time highs and have fared better than enterprise software companies. The broad-based exposure to software application and infrastructure companies that cater to various end markets makes the fund's expense ratio well worth the price.
Despite strength from Microsoft and Oracle, the ETF is roughly flat year to date -- showcasing the extent of the sell-off in other software stocks.
Proceed with caution
Although SaaS companies benefit from recurring revenue streams, their long-term growth depends on adding new customers and expanding spending from existing customers. Innovation is a key driver of customer retention and expansion, but so is the economic cycle.
The customers of these SaaS companies traverse the whole economy, making SaaS companies particularly vulnerable to the ripple effects of a broader slowdown. Guidance by Salesforce and other companies suggests that customers are maintaining tight spending and are mindful of their costs -- which is a theme worth monitoring for the health of the broader market rally.
The investment thesis for many of these companies hasn't changed, but their valuations are based on sustained growth, so volatility could persist if there's a prolonged slowdown. Investors with a three- to five-year time horizon and a high risk tolerance may want to consider the iShares Expanded Tech-software Sector ETF as a catch-all way to invest in software while achieving diversification benefits.
