← Back to Sidekick
Market Pulse
Friday, June 7, 2024

Small-Cap Software Valuations, A Green Law Raises Red Flags and… ASML

Welcome to this week’s Market Pulse, your 5-minute update on key market news and events, with takeaways and insights from the Sidekick Investment Team. 

Our three stories this week:

  1. Small-Cap Software Valuations
  2. A Green Law Raises Red Flags
  3. ASML & Moore’s Second Law

Adrian (Portfolio Manager), and the rest of the Sidekick team. 

It’s important to note that the content of this Market Pulse is based on current public information which we consider to be reliable and accurate. It represents Sidekick’s view only and does not represent investment advice - investors should not take decisions to trade based on this information.

1) Small-Cap Software Valuations

It’s been a quarter to forget for most small and mid-cap application-software companies as valuation multiples continue to compress, trading on average 4.7x on forward sales vs. large-cap peers at 8.9x [1]. The valuation gap has widened by more than 35% since the beginning of the year alone and the group is now facing the biggest discount to large caps in over a decade. 

Tight spending by small businesses, limited revenue per customer leverage and AI expenditure demands all contributed to limiting the upside to 2024 consensus estimates. Companies like ZoomInfo, Bill and Paycom that target small-and medium-business (SMB) customers had to significantly cut their 2024 sales outlooks, leading to a 20-30% drop in valuation multiples.

UiPath suffered the most significant multiple contraction in this group. The company downgraded its 2024 outlook and its CEO resigned, a deadly combo at a time when investors needed stable leadership to demonstrate that AI is a vital enabler for the automation leader, rather than a major disruptor.

However, with high-multiple valuations collapsing over the past two years, dispersion measures in the sector are at seven-year lows. The average standard deviation of 3.2x on forward sales is well below the 10-year average of 5.3x in Bloomberg’s application-software basket. The difference between minimum and maximum valuation multiples is also down – to 8.7x vs. a 10-year average of 15.8x – limiting the elevated multiples associated with high-growth companies. 

To us this is fertile ground for finding valuation anomalies where smaller software companies with disruptive products, large total addressable markets and proven track records of generating free cash flow are unfairly grouped together with deeply unprofitable, high-risk growth stories. While the recovery of small and medium-sized businesses may have been pushed back to 2025, we are already looking ahead to next year when selecting stocks, seeking those poised for growth as the market rebounds. 

2) A Green Law Raises Red Flags

Green policies often carry an inflationary sting, but few have sparked as much controversy as the EU's new Deforestation Regulation (EUDR)[2]. Set to take effect in December, this law will reshape global trade and supply chains by requiring companies to prove their products aren't linked to deforestation.

While seemingly straightforward, the EUDR's reach is vast, impacting seven commodities –  cattle, cocoa, coffee, palm oil, soy, wood, and rubber – and a wide range of products derived from them. This means everything from coffee to tires could be affected.

The regulation's stringent traceability requirements pose significant challenges, particularly for smaller producers in remote areas who must now trace their products back to specific plots of land. This has already contributed to soaring cocoa prices, as we previously wrote in Market Pulse #63 [3].

Despite EU efforts to provide support, concerns remain about the EUDR's impact on supply chains, production costs, and ultimately consumer prices. Some countries have even accused the EU of "regulatory imperialism," [4] highlighting the tension between environmental protection and economic realities.

The coming months will be pivotal in revealing the EUDR's full impact on global trade and consumer wallets. While a potential delay in enforcement could provide some breathing room, we anticipate the overall effect on companies in our Flagship portfolio to be either marginally positive or neutral. As the situation unfolds, we remain dedicated to ensuring our companies not only comply with the regulations but also actively contribute to advancing the EU sustainability agenda whenever possible.

3) ASML & Moore’s Second Law

Shares in ASML have surged close to 10% on Wednesday, lifting its market capitalisation to EUR390 billion and making it Europe’s second most valuable company. The move coincided with Nvidia overtaking Apple to become the second most valuable company in the world. It was helped by news that ASML is on course to deliver its newest “High NA” chip-making machines, which cost around EUR350 million each, to its primary customers Taiwan Semiconductor Manufacturing Company (TSMC) and Samsung this year.

Semiconductors have been a driving force behind technological progress for decades. Advancements in this field have made computation increasingly accessible and affordable, with transistors becoming exponentially smaller and cheaper over time driven by Moore’s Law [5].

However, while the cost of individual components has plummeted, the facilities required to manufacture them—semiconductor fabs—have become significantly more expensive. In the late 1960s and early 1970s, a fab could be built for around $4 million (equivalent to $31 million today). Modern fabs now command price tags of $10 billion to $20 billion, or even more. For example, Intel's new Arizona fabs are estimated to cost $15 billion each, while Samsung's Texas fab is projected to reach a staggering $25 billion.

Paradoxically, it is the very force that has relentlessly driven down the cost of semiconductors – Moore's Law – that is also responsible for the exponential rise in the cost of building the fabs required to manufacture them. 

Thus Moore’s Second Law (or Rock's Law) states that the cost of a semiconductor fab doubles every four years because as semiconductor components shrink in size, the manufacturing process becomes increasingly complex, requiring cutting-edge technology and meticulous precision. ASML has turned these two principles into the cornerstone of its groundbreaking innovation but the whole WFE (Wafer Fab Equipment) ecosystem is set to benefit for years to come.


[1] Bloomberg Finance LLP. (Sidekick Small/Mid Caps Universe is made of: Bill.com, ZoomInfo, HubSpot, Paycom, Paycor, Dayforce, Paylocity, GoDaddy, Wix, SmartSheet, Asana, Klavyo, UiPath, DocuSign, Twillio, Big Commerce, PagerDuty, SquarSpace, FreshWorks, Appian, Nice & Five9. Sidekick Large Cap Universe is made of: SalesForce, Oracle, SAP, Workday, Adobe,Intuit, Microsoft & ServiceNow)

[2] https://environment.ec.europa.eu/topics/forests/deforestation/regulation-deforestation-free-products_en

[3] https://www.sidekickmoney.com/market-pulse/cocoa-beans-are-beating-nvidia-the-challenge-of-infrastructure-investing-and-a-small-win-for-large-merchants

[4] https://www.reuters.com/business/environment/indonesia-accuses-eu-regulatory-imperialism-with-deforestation-law-2023-06-08/



Please remember, investing should be viewed as longer term. Your capital is at risk — the value of investments can go up and down, and you may get back less than you put in.

Sidekick Money Ltd is a company registered in England and Wales (No. 13882980). Sidekick Money Ltd is authorised and regulated by the Financial Conduct Authority (FRN 984829). Our address is Rivington House, 82 Great Eastern Street, London EC2A 3JF.

Payment and e-money services (Non MIFID related products) are provided by The Currency Cloud Limited. Registered in England No. 06323311. Registered Office: Stewardship Building 1st Floor, 12 Steward Street London E1 6FQ. The Currency Cloud Limited is authorized by the Financial Conduct Authority under the Electronic Money Regulations 2011 for the issuing of electronic money (FRN: 900199)

Sidekick Money Ltd also provides investment management and lending services. These are separate and unrelated to the account and payment services you receive from The Currency Cloud Limited.