Back to top

Image: Bigstock

3 Internet Software Stocks to Buy in a Challenging Industry

Read MoreHide Full Article

The Zacks Internet Software industry is benefiting from accelerated demand for digital transformation and the ongoing shift to the cloud. Moreover, the high demand for SaaS due to the 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 Pinterest (PINS - Free Report) , New Relic 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 compared with pre-COVID levels. This is expected to hurt top-line growth in the near term.

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. Industry participants offer multi-cloud application security and delivery, social networking, online payment and 3D printing applications and solutions. The industry participants use the SaaS-based cloud computing model to deliver solutions to end-users as well as enterprises. Hence, subscriptions are the primary source of revenue. Advertising is also a major source of revenue. 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 #192 that places it in the bottom 24% 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 declined 15.8% over this period against the S&P 500 Index’s rise of 28.3% and the broader sector’s return of 28.2%.

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 3.83X compared with the S&P 500’s 5.09X and the sector’s trailing 12-month P/S of 5.64X.

Over the last three years, the industry has traded as high as 6.82X, as low as 3.25X and at the median of 4.99X, as the chart below shows.

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

3 Stocks to Buy Right Now

Pinterest – San Francisco-based Pinterest is benefiting from user base expansion boosted by coronavirus-led social distancing norms. Availability of features like Today and Shop tab for Pinners are key catalysts. Also, enhanced product offerings, new conversion insights, wider Pinner and advertiser base, simplified ad systems through Verified Merchant Program and Pinterest Partners Program for small businesses and improved advertisers’ ability to measure the effectiveness of their ad spend are expected to boost advertising revenues in the near term. Growing Gen Z and millennial user base is a major growth driver for the long haul.

Shares of this Zacks Rank #2 (Buy) company have declined 51.4% year to date. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The Zacks Consensus Estimate for Pinterest’s fiscal 2021 earnings stands at $1.10 per share, unchanged in the past 30 days.

Price and Consensus: PINS

 

Materialise NV– 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.

Materialise’s stock has declined 58.3% year to date. The consensus mark for its 2021 earnings is pegged at 24 cents per share, unchanged in the past 30 days.

Price and Consensus: MTLS

 

New Relic – The San Francisco, CA-based company is riding on an expanding customer base driven by solid demand for its solutions. At the end of the second quarter of fiscal 2022, New Relic had active customer accounts of 14,300 and net revenue retention rate was 112%.

New Relic’s shares have gained 52.8% year to date. The consensus mark for its fiscal 2022 loss has stayed unchanged at 49 cents per share over the past 30 days.

Price and Consensus: NEWR



See More Zacks Research for These Tickers


Normally $25 each - click below to receive one report FREE:


Materialise NV (MTLS) - free report >>

Pinterest, Inc. (PINS) - free report >>

Published in