Has software stocks sell-off reached a bottom yet?

Software stocks are currently weathering what market observers are calling a “SaaSmageddon”.

Despite a string of solid Q4 earnings reports featuring “beats and raises,” the industry has been hit by a wave of indiscriminate selling that has wiped out hundreds of billions in market value.

This rout was triggered by a toxic cocktail of high valuations, surging capital expenditures, and a growing fear that generative artificial intelligence (AI) might disrupt legacy business models.

However, Citi’s senior equity research analyst Tyler Radke believes the worst of the bleeding may be over, and that “we’re getting close to a bottom” now.

Why Citi believes software sell-off is approaching a bottom

Radke’s optimism lies primarily in the “disconnect” between stock performances and fundamental health.

Speaking recently with CNBC, he agreed that the volume of selling has been unprecedented – but the underlying business trends remain robust.

“Q4 earnings have been solid. You’ve seen beats and raises. New business trends have accelerated. Yet, there’s been pretty indiscriminate selling.”

Tyle Radke particularly pointed to recent price action in HubSpot as a potential sign of exhaustion in downward momentum.

After a period of “heavy liquidation”, HUBS has managed to post three consecutive days of gains.

Plus, since AI concerns have now “broadened out beyond software”, the negative sentiment is now reaching a peak or saturation, which historically precedes price stabilization, the Citi analyst noted.

Is this a ‘go all-in’ sign for investors?

While Tyler Radke sees a bottom forming, he isn’t suggesting investors should throw caution to the wind.

Instead, the Citi analyst advises a disciplined, selective approach, noting the “penalty box” remains open for certain types of companies.  

According to him, software is “still not that cheap” when accounting for stock-based compensation, which is drawing increased scrutiny.

Investors should be wary of legacy Software-as-a-Service (SaaS) businesses that aren’t showing meaningful margin improvement or accelerating growth, the Citi analyst added.

For these names, the absence of a “compelling AI story” or clear path to profitability means they may remain under pressure even if the broader sector recovers.

Radke’s favourite software stock to buy today

For those looking to deploy capital, Radke’s favourite names are those with “best AI stories” – ones that have “exposure to the data layer” or the ability to monetize compute.

Microsoft stands at the top of the list, currently trading at a “rare” discount to the S&P 500, which he revealed has happened only once in the last decade.

The Citi analyst views MSFT stock as uniquely shielded due to the company’s massive distribution and control over user data.

“All that data is ultimately what's going to be powering AI,” he told CNBC, highlighting that Azure’s growth is currently limited only by “intentional supply constraints”.

His $660 price target on Microsoft shares suggests potential upside of a whopping 65% from here.