Down 65% in This Bear Market, Can Atlassian Stock Recover in 2023?

What happened

I know you’re reading this article because you want to know if Atlassian (TEAM 4.23%) stock is going to go up from here. But I think it’s crucial to house that discussion within the broader context of why the stock is down in the first place. And make no mistake about it: Atlassian stock is down big.

According to data provided by S&P Global Market Intelligence, the S&P 500 peaked on Jan. 3, 2022, and has dropped about 19% since — just shy of a 20% decline to qualify for a bear market. And over this time, Atlassian stock is down a painful 65%, as of this writing. And it’s down 72% from its all-time high hit back in October 2021.

So what

The data suggests that Atlassian stock is down because of a broad contraction of software-stock valuations more than anything else.

I believe Atlassian stock was richly valued at its peak. But that’s not really the point I’m making here. The point is, many software stock valuations peaked right around November 2021.

This chart comparing the price-to-sales (P/S) valuations of Atlassian, Cloudflare, and Unity Software — three completing unrelated software businesses — demonstrates a clear trend.

TEAM PS Ratio data by YCharts

What changed in late 2021 to cause such a huge change in stock valuations? News started coming out in September that the Federal Reserve might raise interest rates in 2022, departing from its previous stance to keep rates steady at near-zero until 2023. 

By November 2021, it became clear that rates were indeed going to go up. When rates increase, valuations for stocks drop. And by trading at historically high valuations, software stocks like Atlassian were among the hardest-hit by the economic policy shift.

Now what

High-profit margin businesses are often worthy of a premium valuation. And Atlassian’s gross margin was nearly 83% in its most recent quarter.

Moreover, Atlassian believes it has a large growth opportunity ahead, targeting at least $10 billion in annual revenue within the next few years, compared to the just $2.8 billion it generated during its fiscal 2022.

Being a high-growth, high-margin business, one could make an argument that Atlassian stock is now fairly valued.

The drop in 2022 was about valuation, but I believe a different story will be told in 2023, which could affect Atlassian stock. Many of its customers are in the technology space. And these businesses are slowing down and even laying off workers, which is pointing to slower revenue growth for Atlassian in 2023.

However, Atlassian believes these market dynamics will allow it to take market share long term. Therefore, the company will continue hiring in anticipation of the workforce it will need to reach its $10 billion revenue goal. This may be a long-term strategic victory. But it could also decrease profit margins in the near term.

In my opinion, Atlassian looks poised for slower growth and shrinking margins in 2023, leading me to conclude the stock isn’t in an ideal position for a recovery in the coming year.

Jon Quast has positions in Unity Software. The Motley Fool has positions in and recommends Atlassian, Cloudflare, and Unity Software. The Motley Fool has a disclosure policy.