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4 Software Stocks to Watch for in a Booming 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 been extended to managing infrastructure. The industry is primarily gaining from the ongoing cloud transition. The role of software is evolving. With the continuation of remote work setup and mainstream adoption of hybrid/flexible work model, the demand for voice and video communication software as well as productivity software is expected to increase exponentially. These trends bode well for industry participants like Microsoft (MSFT - Free Report) , Salesforce (CRM - Free Report) , Intuit (INTU - Free Report) and Cadence Design Systems (CDNS - 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-premises 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. Some of the companies specialize in the development and marketing of simulation software (like the computer-aided design or “CAD”, 3D modelling, product lifecycle management or “PLM”, data orchestration and experience creation), which are widely used by engineers, designers and researchers across a broad spectrum of industries like architecture, engineering and construction; product design and manufacturing; and digital media

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 software as a service or 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 focused 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 a 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 Work to Drive Demand, Worsening COVID-19 Situation a Concern: The 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 is highly evolving with the emergence of a more contagious Omicron variant. Several parts of the world (especially the U.K. and the rest of Europe) are grappling with increasing infection rates, leading to the reimposition of several COVID-19 restrictions. Even the United States is witnessing a surge in the Omicron outbreak. This could affect spending across small- and medium-sized businesses globally. The uncertainty in business visibility could dent 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 #99, which places it in the top 39% of more than 254 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 outperform 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 Jan 31, 2021, the industry’s earnings estimate for 2021 has improved 6.1%.

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

Industry Outperforms Sector and S&P 500

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

The industry has rallied 25.1% over this period compared with the S&P 500’s rise of 18.4% and the broader sector’s increase of 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 32.9X compared with the S&P 500’s 20.65X. It is also above the sector’s forward-12-month P/E of 26.08X.

Over the last five years, the industry has traded as high as 37.26X, as low as 22.60X and at the median of 27.07X, as the chart below shows.

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

Forward 12-Month P/E Ratio

4 Software Stocks to Snap Up Right Now

Salesforce: Headquartered in San Francisco, CA, Salesforce is the leading provider of on-demand Customer Relationship Management software, enabling organizations to manage critical operations, such as sales force automation, customer service and support, marketing automation, document management, analytics and custom application development.

Salesforce is benefiting from a robust demand environment as customers are undergoing a major digital transformation. The rapid adoption of its cloud-based solutions is driving demand for its products. Salesforce’s sustained focus on introducing more aligned products per customers’ needs is driving the top line. The recent acquisition of Slack would position the company as a leader in the enterprise team collaboration solution space and compete with Microsoft’s Teams product.

Salesforce sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The Zacks Consensus Estimate for the company’s fiscal 2022 earnings is at $4.68 per share, up 6.4% in the past 60 days.

Price and Consensus: CRM

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. Teams’ user growth is gaining from the continuation of remote work and the implementation of a flexible work model. The solid uptake of new Xbox consoles is aiding the gaming segment performance.

Shares of Microsoft have returned 33.5% in a year’s time. The Zacks Consensus Estimate for this Zacks Rank #2 (Buy) company’s fiscal 2022 earnings is pegged at $9.14 per share, up 2 cents in the past 60 days.

Price and Consensus: MSFT


 

Intuit: Mountain View, CA-based Intuit is a business and financial software company that develops and sells financial, accounting and tax preparation software and related services for small businesses, consumers and accounting professionals globally.

Intuit is benefiting from strong momentum in online ecosystem revenues and solid professional tax revenues. The TurboTax Live offering is also driving growth in the Consumer tax business. Solid momentum in the company’s lending product, QuickBooks Capital, remains a positive factor. Moreover, the company’s strategy of shifting its business to a cloud-based subscription model will help generate stable revenues over the long run.

Shares of Intuit have returned 45.3% in a year’s time. The Zacks Consensus Estimate for this Zacks Rank #2 company’s fiscal 2022 earnings is pegged at $11.68 per share.

Price and Consensus: INTU


 

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 opportunities 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 9.4%. The consensus mark for this Zacks Rank #2 company’s 2021 earnings is pegged at $3.25 per share, unchanged in the past 60 days.

Price and Consensus: CDNS