To The Moon

Today, let's exploring themes for 2025.

It should be noted that alpha selection will become increasingly important in 2025, with significant differences expected between sectors and companies.

As investors, we should consider which themes or sectors should include and important considerations :

1. There’s no need to hedge against a hard landing, as this risk is already addressed at the allocation level by reducing delta.

2. The chosen sector should have strong fundamentals, includIing healthy revenue growth, profitability, and cash flow, and it should not be a sunset industry. This ensures that even if the market experiences a significant pullback, the sector has recovery potential, avoiding forced losses during downturns.

3. Industries driven primarily by long-term expectations—like quantum computing or nuclear energy—are excluded. While they may hold great potential in the long run, their current valuations largely reflect distant expectations. Should market sentiment shift, these industries could struggle to return to their highs for an extended period. By the time the market returns to these themes next time, the star companies may have shifted.

4. Valuations must be reasonable and not at historical highs.

5. During favorable economic conditions, the sector’s performance should exceed current market expectations, ensuring sufficient upside potential for stock prices.

In summary, the ideal investment opportunity would have reasonable valuations, resilience to a hard landing (declines can recover), and significant upside during favorable economic conditions. Put simply, the risk-reward profile should be attractive. After considering various options, I’ve zeroed in on the SaaS sector. Let me explain my reasoning.

Valuation Logic in the SaaS Industry

Let’s first examine SaaS valuations. SaaS companies are typically valued using EV/Forward Revenue, primarily because their revenues are often recurring and highly predictable. The most important factors influencing valuation multiples are future revenue growth expectations and free cash flow (FCF) margin, with revenue growth carrying greater weight. Other metrics often considered include Net Revenue Retention (NRR), Customer Lifetime Value (CLV), and Customer Acquisition Cost (CAC).

During the 2021 bull market, SaaS companies were a market favorite, and their valuation frameworks were thoroughly studied. Below is a chart showing the valuations and projected revenue growth for 63 publicly listed SaaS companies. On the X-axis is the consensus 2025 revenue growth forecast, while the Y-axis represents the current EV/2025 estimated revenue multiple. As the chart shows, there is a clear positive correlation between growth expectations and valuation multiples: the higher the expected growth, the higher the valuation multiple.

Source： FactSet, US Tiger Securities

$CrowdStrike Holdings, Inc.(CRWD)$ $Salesforce.com(CRM)$ $ServiceNow(NOW)$ $Snowflake(SNOW)$ $GitLab, Inc.(GTLB)$ $Docusign(DOCU)$ $Okta Inc.(OKTA)$ $Zscaler Inc.(ZS)$ $Palo Alto Networks(PANW)$ $C3.ai, Inc.(AI)$ $Zoom(ZM)$ $Workday(WDAY)$ $HubSpot(HUBS)$

However, focusing solely on growth without considering profitability is incomplete. In the SaaS industry, profitability is often measured using FCF margin. The Rule of 40 is a common metric that combines growth and profitability:

Rule of X = x * Revenue Growth Rate + FCF Margin

Here, x is typically 2 or higher, meaning growth should be weighted at least twice as much as profitability. Market data supports this, showing that Rule of X better explains valuation differences among SaaS companies. Below is a chart showing the relationship between Rule of X (with x = 2) and EV/Revenue. As expected, the two are positively correlated.

In summary, SaaS valuations hinge on EV/Forward Revenue multiples, which are determined by growth and profitability, with growth carrying greater weight. Notably, the weight of growth (x in the Rule of X) isn’t fixed. For instance, during the 2021 pandemic, when cloud adoption surged, x was significantly higher than 2.

Source： FactSet, US Tiger Securities

SaaS Valuation Trends

Below is a chart showing the average valuation, growth, and FCF margin trends for 63 major listed SaaS companies over the past few years. Valuations are based on the EV/Forward Revenue multiple at the end of each year. For example, the 2020 valuation is EV divided by the consensus revenue estimate for 2021.

The orange line represents past and projected revenue growth, while the gray line shows historical and expected FCF margins. The current valuation stands at 8.2x 2025E Revenue, significantly below the peak of nearly 20x at the end of 2021 (over 25x at the bull market peak). While FCF margins have improved significantly (from 5% to 20%), revenue growth has slowed sharply (from 35% to 14%). This aligns with the Rule of X: given today’s growth and margin expectations, x in 2021 was approximately 2.62—31% higher than the current x.

Source： FactSet, US Tiger Securities

Below is a five-year performance comparison between the SaaS-focused ETF $WisdomTree Cloud Computing Fund(WCLD)$ and the Nasdaq ETF $Invesco QQQ(QQQ)$ . During the pandemic bull market, SaaS significantly outperformed the $.IXIC(.IXIC)$ $NASDAQ 100(NDX)$ but has underperformed since 2022. Despite recent strength, the five-year cumulative return for SaaS still lags the Nasdaq, highlighting the impact of slowing revenue growth on SaaS performance.

A graph of stock market Description automatically generated,Source:Tradingview

Since 2022, SaaS growth has slowed for several reasons:

• Post-pandemic normalization: COVID-19 accelerated digital transformation, but as urgent demand subsided, growth rates returned to normal.

• Macroeconomic challenges: Slower economic growth, inflation, and Fed rate hikes have made companies prioritize ROI when adopting SaaS, particularly SMBs.

• Market saturation: Some SaaS segments have reached saturation, slowing customer acquisition and increasing competition.

• Tighter funding: Early-stage SaaS companies often burn cash to drive growth, but rising interest rates and a tougher funding environment have forced many to prioritize profitability.

AI Could Drive SaaS Outperformance in 2025

The section above outlined the valuation logic for the SaaS sector and the reasons for its underperformance in recent years (primarily due to a significant slowdown in growth). Let’s now analyze why I believe SaaS could deliver standout performance in 2025. Undoubtedly, the most prominent narrative in the market right now is AI’s transformative impact on productivity.We believe that AI significantly enhances employee efficiency. The eventual outcome is likely to be fewer employees achieving the same level of output. This transformation has already begun in real life. For instance, I use AI extensively in my research work. It’s no exaggeration to say that tasks that previously required an hour of searching online can now be completed in five minutes with ChatGPT. Based on my experience, AI still struggles with certain specific use cases, but I believe its role will grow as industry-specific models evolve. To quantify this, AI has currently improved my productivity by about 30%, and I can clearly see a path for this figure to reach 100% within the next five years—meaning completing the same tasks in half the time or doubling output in the same amount of time.

While AI infrastructure—semiconductors, foundational models, and public clouds—has been the primary beneficiary in recent years, SaaS companies are well-positioned to capitalize on AI adoption across industries. Most SMBs lack the technical expertise to develop in-house AI tools and will rely on SaaS providers for standardized, customizable AI solutions. SaaS companies already have existing customer relationships, making it easier to cross-sell AI-enhanced products.

Unfortunately, over the past two years, AI-related gains in the secondary market have primarily concentrated in semiconductors (demand for computing power), foundational models, and public clouds (data storage, model training, and inference)—essentially the AI infrastructure layer. While application-layer development has progressed rapidly, there are few suitable direct investment targets in the secondary market. These areas, by their nature, involve high barriers to entry or massive capital expenditures, meaning that large companies have been the primary beneficiaries of AI’s rapid development. This partly explains why the U.S. stock market’s gains over the past two years have been driven predominantly by large-cap companies.

However, this situation is poised to change. As AI technology matures, 2025 could see accelerated exploration of AI applications across industries. Currently, AI adoption is mainly concentrated among tech companies and large enterprises with the financial resources to invest. But with Fed rate cuts (lowering financing costs), Trump’s expected deregulation, and tax reductions, 2025 could witness a growing number of small and medium-sized enterprises (SMEs) adopting AI. This trend could benefit SaaS companies for a simple reason: SMEs and even traditional industry giants often lack the technical capabilities of major tech firms to develop their own AI tools in-house. They will need to procure standardized yet somewhat customizable AI products from external providers. SaaS companies, already doing business with these clients, are naturally positioned to cross-sell their AI-enhanced products. SaaS firms are already providing a range of solutions to clients, and by leveraging their technical expertise to integrate AI into existing products, they can offer AI tools tailored to customer needs. Moreover, for businesses already deeply integrated with SaaS solutions, the most straightforward way to explore AI is by procuring AI services from their existing SaaS providers, avoiding the challenges of data migration and workflow disruption.

Take $Salesforce.com(CRM)$ as an example. On September 12 of this year, it launched Agentforce, an AI tool built into its existing platform. Simply put, Salesforce customers can use Agentforce’s low-code tools to design and deploy AI agents tailored to their specific needs. These agents can handle a wide range of tasks, including responding to customer inquiries and automating back-end operations, all while being fully integrated into Salesforce’s existing ecosystem (e.g., Sales Cloud, Service Cloud, Marketing Cloud). Use cases include customer support, automated marketing, personalized recommendations, and order management. Agentforce was officially made available to customers on October 24, and within just over a month, Salesforce’s December 4 earnings call revealed that it had already signed over 200 deals, with thousands more in the pipeline. Customers include FedEx, Adecco, Accenture, Ace Hardware, IBM, and RBC Wealth Management, demonstrating the strong interest in AI across industries.

Of course, Salesforce is just one example of AI adoption within the SaaS sector. Companies across various sub-segments are incorporating AI into their products to varying degrees. For instance, Shopify uses AI to optimize e-commerce user experiences, Snowflake leverages AI for advanced data analytics, Zoom uses AI to generate real-time transcripts, GitLab applies AI to code review, and Crowdstrike employs AI for security risk detection. SaaS companies are particularly well-suited for AI transformation because they already have established customer relationships. By simply upgrading their existing products with AI capabilities and demonstrating the added value to clients, they can drive willingness to pay higher fees. For businesses, justifying additional SaaS budgets becomes straightforward if the AI enhancements demonstrably improve efficiency—be it through higher sales or streamlined operations.

Returning to the chart below, SaaS sector growth has declined from 44% in 2020 to 17% this year. Current consensus projects further deceleration to 14% by 2025. However, in an environment of rate cuts, deregulation, and tax reductions, businesses will actively explore AI adoption in 2025, potentially driving SaaS sector growth to exceed expectations. As mentioned earlier, growth carries greater weight in SaaS valuations. During periods of industry tailwinds, the market may further increase the weight of growth (x in the Rule of X), thereby raising both Forward Revenue and valuation multiples for the SaaS sector and significantly boosting stock prices.

Source： FactSet, US Tiger Securities

Finally, a few highlight of risks:

1. As stated earlier, the above scenario assumes no hard landing or significant economic slowdown in the U.S. If a hard landing occurs, SaaS companies will likely face notable declines, with tech firms generally experiencing steeper pullbacks.

2. The recent rally in SaaS stocks has likely priced in some of the potential upside. Patient investors might wait for better entry points.

3. Unlisted startup SaaS companies could develop superior AI products, creating competition for market share with publicly traded firms.