The recent software sector sell-off, driven by fears over Artificial Intelligence (AI), has created potential long-term buying opportunities. Consider Adobe (ADBE), which is trading at a decade-low valuation of 11 times free cash flow. For a unique way to invest in the AI theme, look at Zoom (ZM), which trades cheaply at 9 times free cash flow. ZM offers investors indirect exposure to the disruptive AI company Anthropic through its multi-billion dollar investment stake. When evaluating opportunities, prioritize companies with durable advantages like proprietary data and high switching costs.

Software Sector

• The podcast highlights a significant sell-off across the software industry, with major companies like Adobe, Salesforce, and ServiceNow down double-digits from their highs.
• The primary cause of the downturn is investor fear about the disruptive impact of Artificial Intelligence (AI).
• The core concern is that AI will lower barriers to entry for new competitors, reduce the pricing power of existing software companies, and potentially make some products obsolete.
• The recent rollout of AI plugins from Anthropic's Claude, which can perform complex white-collar tasks, was a major catalyst for the sell-off.
• A counter-argument was presented by Nvidia CEO Jensen Huang, who called the idea that AI will replace software companies "the most illogical thing in the world."

Takeaways

• The software sector is facing significant uncertainty due to the perceived threat from AI. This has created a broad sell-off, which may present opportunities in high-quality companies that have been unfairly punished.
• Investors should focus on identifying software companies that are likely to be resilient to the AI threat over the long term.
• Key characteristics to look for in a durable software company include:
  • Owning its own proprietary data.
  • Having high switching costs (it's difficult or expensive for customers to leave).
  • Offering deeply embedded services that are critical to a customer's workflow.
• The key question for investors is not which stocks look cheap now, but which companies will still be thriving in 10-20 years.

Adobe (ADBE)

• The stock is down 58% from its highs.
• It is currently trading at a valuation of 11 times free cash flow, which is noted as its lowest valuation in over 10 years.

Takeaways

• Adobe is presented as a potential bargain due to its historically low valuation.
• For investors who believe in the company's long-term prospects and ability to navigate the AI landscape, the current price could be an attractive entry point.

Duolingo (DUOL)

• The stock is trading at 13 times free cash flow.
• This valuation is presented alongside its strong 40% revenue growth in the last quarter.
• A major risk was highlighted: when factoring in the high levels of stock-based compensation (SBC), the valuation rises significantly to 34 times free cash flow.

Takeaways

• On the surface, Duolingo looks like a fast-growing company at a reasonable price.
• However, investors need to be cautious. The high amount of stock given to employees (SBC) makes the company much more expensive than it first appears. This means the stock may not be as cheap as the initial numbers suggest.

Monday.com (MNDY)

• The stock has dropped to a valuation of 11 times free cash flow.
• This is despite the company having strong triple-digit user retention, meaning it is very good at keeping its customers.
• Similar to Duolingo, a risk was highlighted: after adjusting for stock-based compensation, the valuation increases to 23 times free cash flow.

Takeaways

• Monday.com shows strong business fundamentals with excellent customer retention, and its valuation seems low.
• As with Duolingo, investors should look beyond the simple valuation metric. The "true" valuation is more than double when accounting for stock-based compensation, making it less of a clear-cut bargain.

Zoom Communications (ZM)

• Zoom is described as a "surprising exception" to the software sell-off, with its stock up about 5% over the past month.
• It trades at a valuation of 9 times free cash flow.
• The reason for its recent positive performance is its reported $2 to $4 billion stake in the AI company Anthropic, the creator of Claude.

Takeaways

• Zoom's stock performance is currently tied to its investment in Anthropic, the very AI company causing disruption in the software sector.
• This makes ZM an indirect way to invest in the growth of a leading-edge private AI company. The company's core business is valued cheaply, with the AI investment providing a potential upside catalyst.