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3 Internet Software Stocks to Buy in a Challenging Industry

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The Zacks Internet Software industry is benefiting from accelerated demand for digital transformation and the ongoing shift to cloud. Moreover, high demand for SaaS due to increasing need for remote working, learning and diagnosis software as well as cybersecurity applications has been a major driving factor amid the disruptions caused by the coronavirus outbreak.

Industry participants like F5 Networks (FFIV - Free Report) , Covetrus (CVET - Free Report) and Materialise (MTLS - Free Report) are gaining from accelerated demand for social networking, cloud and digital services. However, a number of industry participants are dependent on advertising spending by customers, which is expected to remain sluggish due to coronavirus-related headwinds.

Industry Description

The Zacks Internet Software industry comprises companies offering application performance monitoring as well as infrastructure and application software, DevOps deployment and Security software. Multi-cloud application security and delivery F5 Networks, social networking and media providers like Pinterest, Twitter (TWTR - Free Report) and Bumble, online payments company PayPal (PYPL - Free Report) and 3D printing applications provider Materialise are notable companies in this industry. The industry participants use SaaS-based cloud computing model to deliver solutions to end-users as well as enterprises. Industry participants target a variety of end-markets, including banking & financial services, service providers, federal governments and animal-health technology and services.

4 Trends Shaping the Future of the Internet Software Industry

Growing Adoption of SaaS: The industry is benefiting from continued demand for digital transformation. Growth prospects are alluring primarily due to rapid adoption of SaaS, which offers a flexible and cost-effective delivery method of applications. It also cuts down on deployment time compared to legacy systems. SaaS attempts to deliver applications to any user, anywhere, anytime and on any device. It has been effective in addressing customer expectation of seamless communications across multiple channels, including voice, chat, email, web, social media and mobile. This drives customer satisfaction and increases retention rate, thereby driving the top line of industry participants. Moreover, the SaaS delivery model has supported industry participants to deliver software applications amid coronavirus-led lockdowns and shelter-in-place guidance. Remote working, learning and diagnosis have also boosted demand for SaaS-based software applications.

Pay-As-You-Go Model Gaining Traction: The increasing customer-centric approach is allowing end-users to perform all the required actions with minimal intervention by the software provider. Moreover, the pay-as-you-go model helps Internet Software providers scale their offerings according to the needs of different users. Further, the subscription-based business model ensures recurring revenues for industry participants. The affordability of the SaaS delivery model, particularly for small and medium businesses, is also a major driver. The cloud-based applications are easy to use. Hence, the need for specialized training reduces significantly, which lowers expenses, thereby driving profits.

Ongoing Transition to Cloud Creates Opportunities: Additionally, the growing need to secure cloud platforms, amid growing incidence of cyber-attacks and hacking, drives demand for web-based cyber security software. Further, as enterprises continue to move their on-premise workload to cloud environments, application and infrastructure monitoring is gaining importance. This is creating more demand for web-based performance management monitoring tools.

Regulations Marring Prospects: Increasing worldwide regulations related to data privacy, and data protection and accessibility do not bode well for the industry participants. The implementation of General Data Protection Regulation, which took effect on May 25, 2018 in the EU, adds to the concerns. Moreover, California Consumer Privacy Act (CCPA), which restricts sales of user data among other things, is a headwind to industry participants. Further, lower ad-spending due to the coronavirus outbreak hinders sector growth.

Zacks Industry Rank Indicates Dim Prospects

The Zacks Internet Software industry, within the broader Zacks Computer And Technology sector, carries a Zacks Industry Rank #186 that places it in the bottom 26% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dim near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Despite the gloomy industry outlook, a few stocks have the potential to outperform the market. But before we present the top industry picks, it is worth taking a look at the industry’s shareholder returns and current valuation first.

Industry Lags Sector and S&P 500

The Zacks Internet Software industry has underperformed the broader Zacks Computer And Technology sector as well as the S&P 500 Index in the past year.

The industry has rallied 15.8% over this period compared with the S&P 500 Index’s rise of 36.8% and the broader sector’s return of 40.7%.

 

One-Year Price Performance

Industry's Current Valuation

On the basis of trailing 12-month price-to-sales (P/S), which is a commonly used multiple for valuing Internet Software stocks, we see that the industry is currently trading at 11.34X compared with the S&P 500’s 6.04X and the sector’s trailing 12-month P/S of 6.05X.

Over the last five years, the industry has traded as high as 15.36X, as low as 3.95X and at the median of 7.46X, as the chart below shows.

Trailing 12-Month Price-to-Sales (P/S) Ratio

3 Stocks to Buy Right Now

F5 Networks – Seattle, WA-based F5 Networks is gaining traction from strong software growth, backed by a solid uptick in public cloud and security offerings. Also, it is benefiting from growing demand for consistent application security across multi-cloud environments, which is aiding revenue growth. Acceleration in NGINX, ELA and Virtual Edition subscription software deals is a positive. The BIG-IP Cloud Edition is also expected to be a key growth driver. The is incorporating more automation and orchestration on its platforms to enable quicker application provisioning.

Shares of this Zacks Rank #1 (Strong Buy) company have returned 51.4% year to date. The Zacks Consensus Estimate for the company’s fiscal 2021 earnings stands at $10.61 per share, up 3.5% in the past 30 days. You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: FFIV

 

Materialise – This Belgium-based 3D printing software provider is riding on strong demand for its solutions. The company is expected to benefit from strong growth in the medical space. Materialise’s expanding footprint in Europe is a key catalyst.

This Zacks #2 Ranked company’s stock has declined 13.7% year to date. The consensus mark for its 2021 earnings is pegged at 7 cents per share improving against loss of 22 cents in the past 30 days.

Price and Consensus: MTLS

 

Covetrus – The Portland, ME-based company is riding on strong demand for online solutions in veterinarian practice. This presently Zacks #2 Ranked company is helping veterinarians expand their digital presence. Moreover, robust pet adoption and higher incremental spending on pet care bode well for the company.

Covetrus’ prospects in 2021 are likely to be driven by its solid prescription management business. The company’s investment in extending its pharmacy capacity and innovative solutions are major levers. The acquisition of VCP is expected to boost Covetrus’ footprint among veterinarians in the long haul.



Covetrus’ shares have gained 9.4% in the past year. The consensus mark for its 2021 earnings has stayed unchanged at 95 cents per share over the past 30 days.

Price and Consensus: CVET