🤏 No margin for error

Why do investors like software stocks? Because they have high recurring revenues and extremely high margins.

Why are investors worried about the impact of AI on software stocks? At the most basic level, AI tools reduce the barriers to entry and the cost of creating software.

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 cratered over 17% 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.

The Takeaway

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.

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A lack of rental cars was a big issue for American travelers in 2021.

A fresh supply of rental car company shares may become a big issue for fans of the Avis short squeeze.

• After the close on Wednesday, following its whopping 38% plunge, the company announced that it would be releasing its Q1 results on April 29. Why is that important?

• It would seem prudent for Avis’ management to take advantage of its richly valued shares to raise money. Its forward price-to-earnings ratio has spiked to above 135x during this parabolic advance, and analysts at JPMorgan just downgraded the shares to “underweight,” citing an “unsustainable valuation.”

• A share offering would alleviate one of the presumptive factors behind the ferocity of Avis’ 427% gain from March 30 through Wednesday’s close: that its two biggest holders dominate the float, and as such, it may be difficult for short sellers to extricate themselves from their bets against the stock. 

• That angle may have already passed its best-before date, however, as trading volumes in excess of $19 billion this week somewhat undermine the argument that short sellers struggling for liquidity are locked into losing positions.

It’s impossible to tell if Avis pulled forward the date of its earnings in order to capitalize on its elevated stock price. But we’d be remiss not to note that Avis has not released its Q1 results in the month of April since 2006.

The Takeaway

Share offerings are what companies that benefit from big spikes out of nowhere tend to do (ask AMC!), unless they can’t. And if they can’t, they aim to find a way around that (ask GameStop!).

About two years ago, during the return of Roaring Kitty meme mania 2.0, the video games and collectibles retailer was seemingly constrained from offering shares because it was in a “blackout period” ahead of earnings (which had been scheduled for June 7). As such, management released preliminary results on May 17 along with plans to sell up to 45 million shares on the open market.

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Investor excitement over Tesla’s surprisingly good earnings report Wednesday quickly faded as it became clear that the financial pain they’d been bracing for is still ahead — and likely worse than expected. On the earning’s call, CEO Elon Musk brought expectations further down to earth — a real change from someone better known for promising the stars.

What he said

• ⚽️ Spursy: Markets are pricing in a 58% chance* that Tottenham Hotspur defeats Wolverhampton this weekend in the English Premier League, yet another in a sequence of close calls that is truly a must-win for the beleaguered Spurs. Wolverhampton is already a lock to face relegation, but Tottenham is currently contending with a humiliating 48% chance that it’ll be relegated down.

• 💊 Psychedelic: Following the news from the FDA that the federal government will have a decision out on psychedelic treatments sooner than not, the market for “Will the FDA approve any psychedelic substance for medical use before 2027?” has spiked from an implied probability of 26% to around 44%. 

• 🏈 NFL: Round 1 of the NFL draft is in the books, and over the next two days, fans of the college game will be keeping a close eye on which school generated the most prospects drafted in the first three rounds, a metric that has long served as a source of bragging rights but in today’s NIL-fueled college game is more important than ever. Ohio State has the best chance of being the school that produces the most players drafted in the first three rounds, but Miami and Texas are still in this. 

*Event contracts are offered through Robinhood Derivatives, LLC — probabilities referenced or sourced from KalshiEx LLC or ForecastEx LLC.

• Premarket earnings: Procter & Gamble, Hasbro, and Gilead