Time To Buy

Greedy when others are fearful

Last week we witnessed what’s known as a bloodbath. $1 trillion in market value was erased. Selling activity reached historic highs. Companies lost 10, 20, 30 percent of their value. If you were looking at your retirement account, you might not have noticed: The S&P 500 fell only slightly. That’s because the massacre took place in one very specific locale — an industry that has dominated portfolios for decades, and that many thought was invincible: software.

All the biggest names went into freefall: Shopify, Atlassian, Salesforce, Adobe, the list goes on. The software industry lost roughly 14% of its value in just one week. Year-to-date, that number is currently about 20%.

Why has this happened? Because of AI. A few weeks ago Anthropic released a new AI tool, Claude Cowork. Then (last week) they released new plug-ins for specific domains: legal work, sales, finance, marketing, etc. OpenAI soon released a similar tool.

Investors soon asked themselves an important question: Isn’t this what every legacy software company does? After that: Did AI just kill software? And finally, their conclusion: Sell everything.

Déjà Vu

We’ve seen this movie before. In 2022 an AI tool called ChatGPT took the internet by storm. Investors asked themselves an important question: Isn’t this what Google does? Within months Wall Street decided search was dead. Google lost as much as 40% of its value that year.

Before that, a social media app called TikTok arrived. Investors asked themselves: Isn’t this what Meta does? As soon as Meta reported a drop in users, $230 billion in market value was lost, the largest 24-hour selloff in stock market history. Meta went on to lose as much as 70% of its value.

More recently, a Chinese AI model called DeepSeek went viral. Investors asked themselves: Isn’t this what OpenAI does? OpenAI was not publicly traded, so selling wasn’t visible. However, fears reverberated into the public markets. Nvidia lost 30% of its value in the following months.

Since each of these market-rupturing events, Nvidia, Meta, and Google have risen 55%, 270%, 630%, from their lows respectively. DeepSeek was not the domestic AI killer investors thought it was. After TikTok, Meta took notes from and launched its own version, Reels, which now boasts an active user base of 2 billion people. After ChatGPT, Google doubled down on AI and eventually launched Gemini, the fastest growing competitor to ChatGPT. Google is now considered the undisputed heavyweight champion of AI.

The pattern here is simple. A transformative technology arrives. Investors indiscriminately decide it’s “over.” They’re not wrong about the technology, but they overestimate its impact. They panic sell, assuming the game is zero-sum. Valuations tank. All of a sudden America’s greatest companies are 50% off. Meanwhile, they continue to deploy armies of talent and capital to sharpen their focus and neutralize the competition. Earnings grow even larger and valuations rip back up again. A couple years later we look back at the chart and think to ourselves: WTF were we thinking? That is, all of us who sold.

There’s Panicking, And Then There’s This

I believe what happened last week in software is no different. It wasn’t a correction, but a full-blown crisis. To paint you a picture: The Relative Strength Index is a formula that captures buying and selling pressure. An RSI score of 30 means a stock is oversold. Last week, software stocks hit an average RSI of 18. I’m not usually one for technical analysis, but in this case it describes well what we saw: armageddon.

On the one hand, concerns are fair. Will AI disrupt software? Yes. Will it put pressure on margins? Certainly. Will SaaS companies have to rethink their distribution? No doubt.

On the other hand, that’s not what markets told us last week. Markets told us software is over — no matter who you are or what you sell. That position is far more questionable. And while I was initially open to hearing it out, I’ve concluded that it doesn’t come from a place of reason but a place of fear. In other words: it’s irrational.

Reality Check

First off, nothing is stopping software companies from integrating AI. The ChatGPT vs. Google story is the perfect example. Just because OpenAI had a more exciting product did not mean Google was dead. Google simply enhanced their existing product with AI features (Google Search is now America’s primary AI interface) and then built an AI chatbot of their own. If SaaS companies were simply dismissing AI, then the bears might have a point, but they aren’t. Software companies are embracing AI across the board.

Secondly, investors are underestimating what a gigantic pain in the ass it is to cancel an enterprise SaaS contract. In more businessy terms: The switching costs are high. The average software sales process can take over half a year to nail down and must be approved by ten different decision-makers. The process is arduous because the contracts are long. And this says nothing of the financial costs associated. The typical Salesforce contact, for example, cannot be canceled for free — the enterprise must pay 100% of the remaining contract value. In other words, switching your software provider as an enterprise is a very big deal. If you’re going to do it, you better have an extremely compelling reason as to why it’s worth it. In addition, all the other executives at the company must agree with you. Pain. In. The. Ass.

Finally, when it comes to enterprise software, security concerns are enormous. Entering into a software agreement basically means handing over all your private data to a third-party and crossing your fingers they won’t lose, use, or abuse it. In other words, it requires trust. This is the number one priority for 80% of IT leaders. More importantly, trust cannot be vibe-coded in a day. Trust must be built over years and even decades. It requires long-standing relationships and a substantial record of success. These are things the legacy companies have and Anthropic doesn’t. Trust and security is an enormous leg-up that cannot be ignored.

Time To Buy

By Thursday afternoon I’d seen enough. Two voices spoke to me in my head. 1) Warren Buffett, who told me to be greedy when others are fearful. 2) Mark Mahaney, who told me to find the “DHQs” (Dislocated High-Quality companies). I decided it was time to buy, and gave myself two options.

Option 1: Buy the whole software basket. I looked at IGV, an ETF of all the big software names, which had gotten crushed. There might be a couple of losers in there, but the average multiple had fallen so far I felt I couldn’t really go wrong. This was the safe option.

Option 2: Stock pick. I.e. personally identify a handful of software names that I consider to be high-quality companies. This was the riskier option as I ran the risk of being wrong and picking the losers. Nevertheless, I went with option 2 as I was feeling bold.

DHQs

On Thursday morning I loaded up on three stocks: Adobe, Salesforce, and ServiceNow. After that, I bought one more: Microsoft. Note: I am not a financial advisor and this isn’t financial advice – I’m just telling you what I did. My reasoning below.

1. Adobe: Adobe is currently trading at a price-to-earnings multiple of 16, which is less than half its five-year average. It is also nearly half of the average P/E multiple of the S&P. It’s extremely cheap. The consensus is that AI will make it irrelevant, but this disregards two key facts. 1) Adobe is already heavily integrating AI. In fact, its AI features are already generating more than $5 billion in annual recurring revenue, which is more than half of Anthropic’s ARR. 2) Its moat is enormous. More than 98% of Fortune 500s use Adobe, and like other software solutions, the product is so deeply integrated across the entire creative workflow that it becomes very difficult to switch solutions. It’s so pervasive that most digital creative roles list Adobe proficiency as a job requirement. An additional tailwind is short-form video. Adobe Premiere Pro is the industry standard for video editing, and most media companies (including ours) are dramatically scaling their short-form video budgets as the medium continues to explode. I discuss this further on the January 29 episode of Prof G Markets.

2. Salesforce: Salesforce is another AI-enabled company that has been written off as dead. Meanwhile, ARR from its AI agent offering quadrupled last quarter and the company continues to be ranked the number one most-trusted CRM in the industry. It’s down more than 40% in the past year, its price-to-earnings multiple is now below the S&P average, and its price-to-cash-flow multiple is about half of its 5-year average. Even if Claude has a more interesting product, I do not believe that will outweigh the immense switching costs — and certainly not in the time it will likely take for Salesforce to build comparable products of its own.

3. ServiceNow: ServiceNow has gotten battered this year — down about 30% in 2026. The consensus is that growth is coming to an end. Meanwhile, its fundamentals tell the opposite story: Subscription revenue grew 21% last quarter, and overall revenue grew 20%. As for its AI capabilities, ServiceNow is more than capable. In fact, the company is on track to generate $1 billion in revenue from its AI products this year. It has also signed multi-year partnerships with OpenAI and Anthropic — more evidence that the AI revolution is not a zero-sum game. I believe OpenAI and Anthropic will grow significantly this year, and so will ServiceNow.

4. Microsoft: If you listened to yesterday’s pod, you’ll notice I didn’t mention Microsoft. That’s because I hadn’t bought at the time of recording. My original view was I didn’t need Microsoft because my exposure was already significant. (MSFT makes up 5% of the S&P.) Upon reflection, however, I decided the valuation was too cheap to ignore. At the time, Microsoft was trading at just 25 times earnings, the lowest of the Mag 7. This is relatively absurd for the reasons I highlighted above, and especially absurd for another key reason: Microsoft owns nearly a third of OpenAI. Even if Microsoft were to have its lunch eaten (I doubt it), the company is contractually entitled to reimbursement. Few companies are better positioned in AI than Microsoft. Current prices do not reflect this.

Efficient-Market Hypothesis

For the most part, I believe in the efficient-market hypothesis — the notion that markets reflect all available information and are smarter than any one individual. I have immense respect for the predictive powers of markets (especially after they correctly predicted 93% of the Golden Globe winners). I don’t purport to be smarter than them.

However, I also believe that every now and then, something extraordinary happens — a political event, a natural disaster, a global pandemic, or indeed, the arrival of a transformative technology. In these instances, I believe the markets can lose their heads. And when that happens, for a brief moment in time, the efficient-market hypothesis goes out the window.

I hereby run the risk of being wrong and losing money. But that’s what it means to be an investor. Plus, if you don’t take a risk every once in a while, well … where’s the fun in that?

Until next week,

Ed