Why has the decline in software stocks on fears of artificial intelligence disruption been so dramatic and with no end in sight? In this Club Check-in, CNBC’s Paulina Ricos and Zeb Fima answer that question by diving into an important concept called terminal value that investors use to value stocks. Software earnings have not collapsed, and next year’s earnings expectations appear to be maintained. Still, this year has seen carnage across the software complex. What has changed is Wall Street’s confidence in how it values these companies over the next few years due to concerns that AI could fundamentally change their long-term profitability. Investors in particular are reconsidering their assumptions about the ultimate value of software companies, essentially the “forever” value of the business. As uncertainty around the premise increases and people begin to ask existential questions, investors will demand lower valuations before buying stocks. This has a big impact on stock prices, as we’ve seen this year with companies like Salesforce, Workday, and ServiceNow. Terminal value may be a new term to some club members, and rightly so. In daily discussions about the stock market, the price-to-earnings ratio receives a lot of attention as a valuation metric. That makes sense when you’re looking just a year or two into the future, or even less. However, if you are looking at valuing a company over multiple years, the most standard method is something called a discounted cash flow (DCF) model. That’s where the final value becomes important. It is an essential element of these models. As Zev explains in the video, small changes in terminal value assumptions can result in much larger changes in the amount investors are willing to pay for a stock today than changes in short-term cash flow projections. For investors, understanding this dynamic can help clarify whether the structural risk concerns driving this selloff are warranted, or whether long-term concerns are creating selection opportunities in stocks that have been overdone. For a complete list of Jim Cramer’s Charitable Trust stocks, see here. Subscribers to Jim Cramer’s CNBC Investing Club receive trade alerts before Jim Cramer makes a trade. After Jim sends a trade alert, he waits 45 minutes before buying or selling stocks in his charitable trust’s portfolio. If Jim talks about a stock on CNBC TV, he will issue a trade alert and then wait 72 hours before executing the trade. The above investment club information is subject to our Terms of Use and Privacy Policy, along with our disclaimer. No fiduciary duties or obligations exist or arise from your receipt of information provided in connection with the Investment Club. No specific results or benefits are guaranteed.
