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4 Business-Software Services Stocks to Watch in a Challenging Industry

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The Zacks Business-Software Services industry is benefiting from heightened demand for digital transformation and the ongoing shift to the cloud. Growing automation business processes across multiple industries and rapidly increasing enterprise data volumes are also driving demand for business software and services. Industry participants like MSCI (MSCI - Free Report) , Tyler Technologies (TYL - Free Report) , TD SYNNEX (SNX - Free Report) and Guidewire Software (GWRE - Free Report) are gaining from these trends.

Companies in this space had benefited from pandemic-induced strong demand for cloud-based services from businesses looking to operate amid lockdowns. However, the growth rate has inched lower with the reopening of economies. Moreover, the industry’s near-term growth prospects are likely to be hurt as organizations push back their investments in big and expensive technology products on growing global slowdown concerns amid the current macroeconomic challenges and geopolitical tensions. These, along with elevated operating expenses related to hiring new employees and sales and marketing strategies to capture more market share, are likely to strain margins in the near term.

Industry Description

The Zacks Business-Software Services industry primarily comprises companies that deliver application-specific software products and services. The applications are typically either license-based or cloud-based. The offerings generally include applications related to finance, sales & marketing, human resource, and supply chain, among others. The industry consists of a broad range of companies offering a wide range of products and services, including business processing and consulting, application development, testing and maintenance, office productivity suits, systems integration, infrastructure services, and network security applications. Some of the companies provide investment-decision support tools. Manufacturing, retail, banking, insurance, telecommunication, healthcare and public sectors are the primary end markets for industry participants.

5 Trends Shaping the Future of the Business-Software Services Industry

Transition to Cloud-Creating Opportunities: Companies in this industry have been gaining from the robust demand for multi-cloud-enabled software solutions, given the ongoing transition from legacy platforms to modern cloud-based infrastructure. These industry players are incorporating artificial intelligence (AI) in their applications to make the same more dynamic and result-oriented. Most industry players are now offering cloud-based versions of their solutions in addition to the on-premise ones, thereby expanding content accessibility. The enhanced interoperability features provide customers with differentiation and efficiency.

Subscription Model Gaining Traction: The industry participants are modifying their business models to cope with clients’ shifting requirements. Subscription and term-license-based revenue pricing models have become highly popular and are now replacing the legacy upfront payment prototype. Subscription-based business models provide increased revenue visibility and higher recurring revenues, which bode well for companies over the long haul. However, due to this transition, the top-line growth of these companies might be affected in the days to come, as term-license revenues include advance payments, whereas subscription-based revenues are a bit delayed.

Continuous M&A to Expand Product Offerings: The players in this industry are resorting to frequent mergers and acquisitions to supply complementary and end-to-end software products. Nonetheless, increasing investments in digital offerings and acquisitions might erode the industry’s profitability in the upcoming period.

Macroeconomic Headwinds Might Hurt IT Spending: Enterprises may postpone their large IT spending plans due to a weakening global economy amid ongoing macroeconomic and geopolitical issues. In July 2022, Gartner lowered its forecast for worldwide IT spending growth rate to 3% from 4% mentioned earlier. The research firm’s report highlights that 2022 IT spending growth will be much slower than 2021 due to spending cutbacks across devices, software, IT services and communication services areas. This is likely to negatively impact the demand for business software solutions and services in the near term.

Elevated Operating Expenses to Hurt Profitability: To survive in the highly competitive business software market, each player is continuously investing in broadening its capabilities. The players in the space are aggressively investing in research and development to enhance their product portfolio. Moreover, companies are investing heavily to enhance their sales and marketing capabilities, particularly by increasing their sales force. Therefore, elevated operating expenses to capture more market share are likely to dent margins in the near term.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks Business-Software Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #213, which places it in the bottom 15% 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 dismal 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.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of the negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s earnings growth potential. The industry’s earnings estimate for July-September 2022 quarter has moved a penny lower to 24 cents over the past three months.

Estimate Revision For July-September 2022 Quarter

Despite the gloomy industry outlook, a few stocks are worth watching in 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 S&P 500, Outperforms Sector

The Zacks Business-Software Services industry has underperformed the S&P 500 Index but outperformed the broader Zacks Computer and Technology sector over the past year.

The industry has declined 30.2% during this period compared with the broader sector’s decline of 31.1% and the S&P 500’s decrease of 13.6%.

One-Year Price Performance

Industry's Current Valuation

Comparing the industry with the S&P 500 composite and broader sector on the basis of the forward 12-month price-to-earnings, which is a commonly-used multiple for valuing business-software services stocks, we see that the industry’s ratio of 20.15 is higher than the S&P 500’s 16.92 but slightly lower than the sector’s 20.40.

Over the last five years, the industry has traded as high as 37.75X, as low as 6.60X, and recorded a median of 21.95X as the charts below show.

F12M Price-to-Earnings Ratio (Industry Vs. S&P 500)

F12M Price-to-Earnings Ratio (Industry Vs. Sector)

4 Stocks to Keep a Close Eye On

MSCI: This Zacks #3 Rank (Hold) company offers investment decision support tools, including indexes; portfolio construction and risk management products and services; Environmental, Social and Governance (ESG) research and ratings; and real estate research, reporting and benchmarking offerings. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

MSCI is benefiting from solid demand for custom and factor index modules, a recurring revenue business model and the growing adoption of its ESG solution in the investment process. MSCI’s expanding portfolio of climate tools is expected to drive the top line. Acquisitions have enhanced its ability to provide climate-risk assessment and assist investors with climate-risk disclosure requirements. Moreover, strong traction from client segments like wealth management, banks, broker and dealers is a positive.

Shares of this New York-based company have declined 28.1% during the past year. The Zacks Consensus Estimate for 2022 earnings has moved a couple of cents south to $11.33 per share over the past 30 days.

Price and Consensus: MSCI

Tyler Technologies: This Zacks Rank #3 company is a leading provider of integrated information management solutions and services to the public sector. The company serves its customers both on-premise and in the cloud.

Tyler is benefiting from higher recurring revenues, post-acquisition contributions of NIC, and constant rebound of the market and sales activities to pre-COVID levels. The public sector’s ongoing transition from on-premise and outdated systems to scalable cloud-based systems is a positive. The coronavirus-led remote-working trend is also driving demand for its connectivity and cloud services.

Shares of this Plano, TX-based company have plunged 21.2% over the past year. The Zacks Consensus Estimate for 2022 earnings has moved down by 14 cents to $7.44 per share over the past 60 days.

Price and Consensus: TYL

TD SYNNEX: Founded in 1980, it is a leading business process services company. TD SYNNEX provides a comprehensive range of distribution, logistics and integration services for the technology industry and outsourced services focused on customer engagement to a broad range of enterprises.

TD SYNNEX is benefiting from the hybrid working trend, which is driving demand for offsite-working hardware and software. Moreover, a steady IT spending environment on the back of rapid digital transformation is a positive. Acquisitions and partnerships are helping the company expand its product portfolio.

This Fremont, CA-based company carries a Zacks Rank #3 at present. The Zacks Consensus Estimate for fiscal 2022 earnings has moved up by 4 cents to $11.54 per share over the past 90 days. Shares of SNX have declined 22.8% over the past year.

Price and Consensus: SNX

Guidewire Software: This San Mateo, CA-based company is a provider of software solutions for property and casualty (P&C) insurers. The company's solutions aid in reducing risk via increased productivity, bringing speed to market, digital engagement and simplifying IT infrastructure.

Guidewire is riding on higher subscription revenues, as reflected by its fiscal fourth-quarter results. The company’s subscription-based offerings are gaining from the robust adoption of the InsuranceSuite Cloud platform. Further, its focus on enhancing the Guidewire Cloud platform with new capabilities is expected to boost sales of subscription-based solutions in the long haul. Guidewire’s cloud deployment partner, Amazon Web Services is also gaining traction. Strategic acquisitions and collaborations, along with a less competitive market and strong liquidity position, bode well.

This Zacks Rank #3 stock has plunged 44.6% in the trailing 12 months. The consensus mark for fiscal 2023 is pegged at a loss of 33 cents per share, having narrowed by five cents in seven days’ time.

Price and Consensus: GWRE

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