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3 Software Stocks to Snap Up in a Prospering Industry

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The Zacks Computer Software industry is benefiting from the pandemic-induced accelerated digital transformation drive across the globe. Software is ubiquitous and has become the focal point of technological innovation. Apart from running devices and applications, its usage has extended to managing infrastructure. The industry is gaining primarily from the ongoing cloud transition. The role of software is evolving. Further, with the continuation of remote work set up as well as mainstream adoption of hybrid/flexible work model, demand for voice and video communication software as well as productivity software is expected to jump exponentially. These trends bode well for industry participants like Microsoft (MSFT - Free Report) , Cadence Design Systems (CDNS - Free Report) and PTC Inc (PTC - Free Report) .

Industry Description

The Zacks Computer Software industry comprises companies that provide software applications related to cloud computing, electronic product designing, digital media and marketing, customer relationship management, on-premise as well as cloud-based database management, accounting and tax purposes, human capital management, cybersecurity and application performance monitoring and cloud-based enterprise communications platform among others. Meanwhile, companies like PTC, Autodesk (ADSK - Free Report) , and ANSYS (ANSS - Free Report) develop and market simulation software solutions (like computer-aided design or “CAD”, 3D modelling, product lifecycle management or “PLM”, experience creationand data orchestration), which are used by engineers, designers, academia and researchers across a broad spectrum of industries.

3 Trends Shaping the Future of the Software Industry

Higher Spending on Software Aids Prospects: The industry’s prospects are bright, given higher spending by the enterprises on software procurement. Continued investment in big data and analytics along with the ongoing adoption of SaaS opens up significant opportunities for industry players. Cloud offers a flexible and cost-effective platform to develop and test applications. The deployment time is also much shorter compared with legacy systems. SaaS companies are expected to register strong top-line growth on a higher percentage of recurring revenues, subscription gross margin and a lower churn rate.

Cloud Computing Adoption Gaining Traction: The increasing need to secure the cloud platforms, amid growing incidents of cyber-attacks and hacking, is driving demand for cyber security software. Enterprises are focusing on rapid migration to cloud and DevOps technologies to achieve scalability and agility for software development as well as IT operations. This helps in delivering flawless digital experience to clients. This trend has brought immense value to application and infrastructure performance monitoring. It is driving the demand for performance management monitoring tools that are not only scalable but also suitable for cloud-based environments.

Remote Working to Drive Demand But Evolving COVID-19 Situation a Concern: Continuation of work-from-home and online-learning set up along with the adoption of distributed workforce model is fueling demand for enterprise communication, workspace management, and human capital management software solutions among others. However, the coronavirus situation has become quite unpredictable with the emergence of the more contagious Delta variant strain. Several parts of the world (India, Indonesia, Australia and Japan) are grappling with a massive spike in infection rates, leading to re-imposition of lockdowns. Even some parts of United States are witnessing Delta variant outbreaks. This could affect spending across small- and medium-sized businesses, globally. The uncertainty in business visibility could put a dent on the industry’s performance in the near term.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Computer Software industry is housed within the broader Zacks Computer And Technology sector. It carries a Zacks Industry Rank #121, which places it in the top 48% of more than 253 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bright 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.

Looking at the aggregate earnings estimate revisions, it appears that analysts are gaining confidence in this group’s earnings growth potential. Since Dec 31, 2020, the industry’s earnings estimate for 2021 has improved 14.5%.

Before we present a few stocks that you may want to consider for your portfolio, considering bright prospects, let us look at the industry’s recent stock-market performance and valuation picture.

Industry Lags Sector but Outperforms S&P 500

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

The industry has rallied 39.2% over this period compared with the S&P 500’s rise of 37.1% and the broader sector’s increase of 46.8%.

One-Year Price Performance

Industry's Current Valuation

On the basis of forward 12-month P/E, which is a commonly used multiple for valuing software companies, we see that the industry is currently trading at 34.51X compared with the S&P 500’s 21.78X. It is also above the sector’s forward-12-month P/E of 28.65X.

Over the last five years, the industry has traded as high as 35.47X, as low as 21.80X and at the median of 26.49X, as the chart below shows.

Forward 12-Month Price-to-Earnings (P/E) Ratio

Forward 12-Month P/E Ratio

3 Software Stocks to Snap Up Right Now

Microsoft: The Redmond, WA-based company is benefiting from momentum in its Azure cloud platform, amid accelerated digital transformation around the globe. The company is now one of the two public cloud providers that can deliver a wide variety of infrastructure-as-a-service (IaaS) and platform-as-a-service (PaaS) solutions at scale.

Microsoft is witnessing growth in the user base of its different applications including Microsoft 365 suite and Dynamics. Recovery in ad and job market boosted LinkedIn and Search revenues. Solid uptake of new Xbox consoles is aiding the gaming segment performance. Teams’ user growth is gaining from continuation of remote work as well as the implementation of flexible work model.

Shares of Microsoft have returned 45.7% in a year’s time. The Zacks Consensus Estimate for this Zacks Rank #2 (Buy) company’s fiscal 2022 earnings has moved up 3.6% to $8.61 per share in the past 60 days. You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

Price and Consensus: MSFT

Cadence Design Systems: The San Jose, CA-based company is well-positioned to gain from strength across segments like digital & signoff solutions and functional verification suite. Expanding product portfolio and frequent product launches are a key catalyst. Increasing investments on emerging trends like Internet-of-things (IoT), augmented and virtual reality (AR/VR) as well as autonomous vehicle sub-systems present significant growth opportunity for the company in the long haul. The recent acquisitions of Pointwise and NUMECA are expected to boost the top line.

In the past year, shares of Cadence have returned 63.4%. The consensus mark for this Zacks Rank #2 company’s 2021 earnings has moved 4.3% north to $3.17 per share in the past 60 days.

Price and Consensus: CDNS



 

PTC: This Boston, MA-based company is benefiting from the digital transformation by enterprises resulting in strong annualized recurring revenues (ARR). PTC is witnessing robust adoption of Vuforia-Chalk, Vuforia Expert Capture solution along with ThingWorx and Windchill platforms as well as the Onshape suite.

Acquisition of Arena Solutions also bodes well. Arena Solutions’ takeover will enable PTC to provide customers with a comprehensive SaaS solution that encompasses CAD and PLM offerings.

Shares of PTC have returned 54.8% in a year’s time. The consensus mark for this Zacks Rank #2 company’s fiscal 2021 earnings has risen 6.3% to $3.54 per share in the past 60 days.

Price and Consensus: PTC