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4 Stocks to Watch From a Prospering Business-Software Services Industry

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The Zacks Business-Software Services industry is benefiting from the heightened demand for digital transformation and the ongoing shift to the cloud. The growing automation of business processes across multiple industries and rapidly increasing enterprise data volumes are also driving the 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 the pandemic-induced strong demand for cloud-based services from businesses looking to operate amid lockdowns. However, the growth rate has decreased with the reopening of economies and ongoing macroeconomic headwinds, including inflationary pressure and a high interest rate, which is negatively impacting IT spending. Additionally, 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 resources 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 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) into 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 on-premise ones, thereby expanding content accessibility. Enhanced interoperability features provide customers with differentiation and efficiency.

Subscription Model Gains 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. However, increasing investments in digital offerings and acquisitions might erode the industry’s profitability in the upcoming period.

Softening IT Spending to Impact Prospects: The near-term prospects of industry participants might be hurt by softening IT spending. Rising interest rates and inflationary pressures are hurting consumer spending. Meanwhile, enterprises are postponing their large IT spending plans due to a weakening global economy amid ongoing macroeconomic and geopolitical issues.

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 portfolios. Moreover, companies are investing heavily to boost 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 Bright Prospects

The Zacks Business-Software Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #48, which places it in the top 19% of nearly 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all member stocks, indicates solid 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 top 50% of the Zacks-ranked industries is a result of the positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are optimistic about this group’s earnings growth potential.

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

Industry Outperforms the S&P 500 but Lags the Sector

The Zacks Business-Software Services industry has outperformed the S&P 500 Index over the past year but has lagged the broader Zacks Computer and Technology sector performance during the same time frame.

The industry has soared 16.9% during this period, while the broader sector and the S&P 500 have increased 38.7% and 14.9%, respectively.

One-Year Price Performance

Industry's Current Valuation

Comparing the industry with the S&P 500 composite and the 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 21.57 is higher than the S&P 500’s 18.54 but lower than the sector’s 23.33.

Over the last five years, the industry has traded as high as 38.27X and as low as 17.55X and recorded a median of 21.81X, 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 Watch

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

Guidewire’s performance is gaining from higher revenue growth across the subscription and support business segment. Guidewire Cloud continues to gain momentum with eight cloud deals in its last reported quarterly results. The company’s focus on enhancing the Guidewire Cloud platform with new capabilities is expected to boost sales of subscription-based solutions. The company is likely to benefit as insurers modernize their legacy mainframe systems and replace previously modernized on-premise systems. Also, GWRE’s share repurchase program is noteworthy. Strategic acquisitions and collaborations, along with a less competitive market and a strong liquidity position, bode well.

This Zacks Rank #1 (Strong Buy) stock has rallied 47.7% year to date (YTD). The consensus mark for fiscal 2024 earnings is pegged at 74 cents per share, revised 13 cents upward over the past 60 days. You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: GWRE


MSCI: The 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.

MSCI is benefiting from the 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 in climate-risk disclosure requirements. Moreover, the strong traction of client segments like wealth management, banks, brokers and dealers is an upside.

Shares of this Zacks Rank #3 (Hold) company have increased 6.9% YTD. The Zacks Consensus Estimate for 2023 earnings has moved 8 cents north to $13.19 per share over the past seven 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. Tyler serves its customers both on-premise and in the cloud.

Tyler is benefiting from higher recurring revenues, the post-acquisition contributions of NIC and the constant rebound of the market and sales activities to pre-pandemic levels. The public sector’s ongoing transition from on-premise and outdated systems to scalable cloud-based systems is an upside. The growing hybrid working trend is also driving the demand for its connectivity and cloud services. The company’s strong liquidity position is helping it pursue acquisitions, which are expected to continue to drive growth.

Shares of this Plano, TX-based company have soared 27.6% YTD. The Zacks Consensus Estimate for 2023 earnings has been revised upward by a penny to $7.70 per share over the past seven 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 growing hybrid working trend, which is driving the demand for offsite working and learning hardware and software. Strong growth in product areas, such as networking and cloud-plus software-related solutions, is contributing to revenue acceleration in its technology solutions business. 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 2023 earnings has moved up by a penny to $10.81 per share over the past 30 days. Shares of SNX have remained flat YTD.

Price and Consensus: SNX

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