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3 Software Stocks to Watch for in a Thriving Industry

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The Zacks Computer Software industry benefits from the 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 constantly evolving. With the adoption of the hybrid/flexible work model, demand for voice and video communication and productivity software is expected to increase exponentially. These trends bode well for industry participants like Microsoft (MSFT - Free Report) , Manhattan Associates (MANH - Free Report) and Sapiens International Corporation (SPNS - Free Report) . However, inflationary pressure and the uncertainty prevailing over global macroeconomic conditions are a concern.

Industry Description

The Zacks Computer Software industry includes companies that provide software applications related to cloud computing, electronic design automation (primarily for semiconductor and electronics industries), digital media and marketing, customer relationship management, on-premises and cloud-based database management, accounting and tax purposes, human capital management, cybersecurity and application performance monitoring and cloud-based enterprise communications platform. Some companies develop and market simulation software (like computer-aided design or CAD, 3D modeling, product lifecycle management or PLM, data orchestration and experience creation), which engineers, designers and researchers use across various industries like architecture, engineering and construction, product design, 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 enterprises on software procurement. The continued investment in big data and analytics and the ongoing adoption of software as a service or SaaS opens up opportunities for these players. Cloud offers a flexible and cost-effective platform for developing and testing applications. The deployment time is also 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 cloud platforms amid growing cyber-attacks and hacking incidents drives demand for cyber security software. Also, the rapid development of cutting-edge technologies like artificial intelligence, machine learning, and the Internet of Things is leading to increased usage of advanced software applications. Enterprises are focused on rapid migration to the cloud and DevOps technologies to achieve scalability and agility for software development and IT operations. This helps deliver a flawless digital experience to clients. The trend brought immense value to application and infrastructure performance monitoring. It is driving the demand for performance management monitoring tools that are scalable and suitable for cloud-based environments.

Macroeconomic Headwinds a Concern: Global macroeconomic weakness and volatile supply chain dynamics are persistent concerns. Inflation 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. Per a report from Gartner, worldwide IT spending is now projected to reach $5 trillion in 2024, calling for an increase of 6.8% from 2023 levels. This is below the earlier projection of 8% growth by the research firm. The report also highlighted that although generative AI had enough hype, it will not yet have a material impact on IT spending 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 #60, which places it in the top 24% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is 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 Dec 31, 2023, the industry’s earnings estimate for 2023 improved by 2.4%.

Before we present a few stocks 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 Outperforms Sector and S&P 500

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

The industry gained 48.7% over this period compared with the S&P 500 and the broader sector’s increase of 19.2% and 38.6%, respectively.

One-Year Price Performance

Industry's Current Valuation

Based on the forward 12-month P/E, a commonly used multiple for valuing software companies, we see that the industry is currently trading at 33.34X compared with the S&P 500’s 20.52X. It is also above the sector’s forward-12-month P/E of 26.17X.

In the last five years, the industry has traded as high as 37.51X, as low as 22.97X and at the median of 29.85X, as the chart below shows.

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

Forward 12-Month P/E Ratio


3 Software Stocks to Strengthen Portfolio

Manhattan Associates: Atlanta, GA-based Manhattan Associates provides supply chain execution and optimization solutions. It enables operational excellence through its warehouse, transportation, distributed order management, reverse logistics and trading partner management solutions, as well as its RFID, performance management and event management capabilities.

The company recently reported fourth-quarter 2023 results. Total revenues came in at $238.3 million compared with $198.1 million reported in the prior-year quarter. Cloud subscription revenue was $71.4 million compared with $51.7 million in the prior-year quarter. Amid macro weakness, the company remains encouraged by growing market opportunities. It expects revenues for 2024 to increase in the range of 9-10% year over year.

MANH carries 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 MANH 2024 EPS has increased by 3.6% in the past 60 days to $3.76.

Manhattan Associates’ earnings beat the Zacks Consensus Estimate in each of the last four quarters, the average surprise being 27.6%. Shares of MANH have surged 70.6% in the past year.

Price and Consensus: MANH

Microsoft: Microsoft Corporation is one of the largest broad-based technology providers in the world. The company dominates the PC software market, with more than 73% of the market share for desktop operating systems.

Microsoft is riding on strong growth from Intelligent Cloud and Productivity and Business Processes. Intelligent Cloud revenues have been driven by growth in Azure and other cloud services. Productivity and Business Processes revenues continue to increase due to the strong adoption of Office 365 Commercial solutions. Continued momentum in the small and medium businesses and frontline worker offerings as well as a gain in revenue per user, drove top-line growth. Steady performance in Talent Solutions aiding LinkedIn revenues.

However, More Personal Computing revenues are suffering from continued weakness in Windows and Devices businesses. Declining gaming revenues have been a headwind. Increasing spend on Azure enhancements amid stiff competition in the cloud space remains a concern.

MSFT carries a Zacks Rank #2 (Buy). The company’s fiscal 2024 earnings are pegged at $11.60 per share, indicating year-over-year growth of 18.3%. The long-term growth rate is pegged at 16.2%. The stock has gained 51.6% in the past year.

Price and Consensus: MSFT

Sapiens International: Israel-based Sapiens International offers software solutions for the insurance industry globally. The company has a cloud-based SaaS insurance platform that delivers pre-integrated and low-code capabilities across core, data and digital domains to boost digital transformation. Sapiens serves insurers across property and casualty, workers' compensation and life insurance markets. It has more than 600 customers across 30 countries.

Sapiens’ robust product portfolio and solid partner base are expected to boost its top-line growth. For 2023, the company expects revenues between $511 million and $516 million.

The stock carries a Zacks Rank #2. The consensus mark for the company’s 2023 earnings is pegged at $1.33 per share, up 9.9% year over year. Its shares have gained 17.5% in the past year.

Price and Consensus: SPNS


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