Nothing shows traders’ willingness to shoot first and ask questions later (or not bother to ask questions at all!) when the crux of the case for owning software seemingly shows cracks more than the reaction to ServiceNow’s Q1 results and updated outlook.
ServiceNow is cratering after the software company’s Q1 margins came in shy of estimates. Full-year guidance for ServiceNow’s gross and operating margins was revised lower, while subscription revenues got a big bump.
There are some extenuating circumstances that cut both ways: integrating recently acquired businesses is the proximate cause of the expected sales bump and operating margin pressure, according to management.
But given how important margins have been to the investment case for software stocks — and the significant profitability premium they’ve enjoyed relative to the S&P 500 as a whole — details don’t seem to matter.
In early February, Nvidia CEO Jensen Huang called the idea that the software industry would be replaced by AI the “most illogical thing in the world,” arguing that AI agents will leverage existing software tools rather than reinvent them.
(For what it’s worth, my view is that if AI is intelligent in a transcendent way, then reinventing the wheel is absolutely something you should expect. If AI is just fishing in the ocean of human consciousness with the best net possible, then it may work within our existing toolbox. I’m thinking about the story of why it took so long to develop a sewing machine — inventors were trying to mimic the motion of sewing by hand rather than taking a novel mechanical approach.)
But I digress. The bear case for software is that AI tools render many established giants obsolete. But going the way of the woolly mammoth isn’t something that happens overnight. You won’t be able to find any of them to ask, obviously, but I’m told it was a 10,000- to 16,000-year process.
Well before obsolescence comes the threat of incremental substitution. And margin pressure would be one way you’d expect competitive pressures to be absorbed. At the surface level, ServiceNow is affirming a base case for software stocks that traders have spent months fearing, which still apparently hasn’t taken the industry to levels where it’s viewed as attractively valued.
