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Computer Software Stock Outlook Bright With Solid Prospects

Aniruddha Ganguly

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-premise as well as cloud-based database management, accounting & tax purposes, human capital management, cybersecurity and application performance monitoring, among others.

Major companies in the industry include Adobe Systems (ADBE), Cadence Design System (CDNS), Citrix (CTXS), Intuit (INTU), Microsoft (MSFT), Oracle (ORCL), salesforce.com (CRM) and Synopsis (SNPS). Meanwhile, companies like Autodesk (ADSK) and ANSYS (ANSS) develop and market simulation software globally.

Software is ubiquitous and has become the focal point of technological innovation. The industry is highly dynamic. The primary mode of software deployment has shifted from legacy on-premise to cloud architecture with SaaS becoming the preferred delivery mode.

Here are the four major industry themes:

  • The software industry is benefiting from the continued digital transformation drive. The last few years have witnessed a series of breakthroughs in cloud computing, predictive analysis, AI, digital personal assistants and IoT, which have set the stage for strong growth. The near-term prospects are bright, given increased spending by enterprises on software procurement.

 

  • Continued enterprise investment in big data and analytics along with the ongoing adoption of SaaS opens up significant opportunity for industry players. Notably, cloud offers a flexible and cost-effective platform to develop and test applications and the deployment time is also much shorter compared to 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.

 

  • The increasing need to secure cloud platforms, amid growing incidents of cyber-attacks and hacking, drives demand for cyber security software. Further, enterprises are focusing on rapid migration to cloud and DevOps technologies to achieve scalability and agility for software development as well as IT operations, which helps in delivering flawless digital experience to clients. This trend has brought immense value to application and infrastructure performance monitoring. It is driving demand for performance management monitoring tools that are not only scalable but also suitable for cloud-based environments.

 

  • Industry participants are facing coronavirus (COVID-19)-induced challenging demand environment, which is expected to hurt prospects in the near term. However, the work-from-home and online-learning wave led to a spike in relevant software demand, primarily enterprise communication, workspace management, human capital management (HCM) among others.


Zacks Industry Rank Indicates Bright Prospects

The Zacks Computer Software is housed within the broader Zacks Computer And Technology Sector. It carries a Zacks Industry Rank #68, which places it in the top 27% 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 continued outperformance in the near term. 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.

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gaining confidence in this group’s earnings growth potential. Since May 31, 2019, the industry’s earnings estimate for the current year has increased 4.1%.

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 Sector and S&P 500

The Zacks Computer Software Industry has outperformed the broader Zacks Computer And Technology Sector as well as the S&P 500 Index over the past year.

The industry has rallied 17.4% over this period against the S&P 500’s fall of 4.6% as well as the broader sector’s dip of 0.9%.

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 26.78X compared with the S&P 500’s 18.10X. It is also above the sector’s forward-12-month P/E of 20.24X.

Over the last five years, the industry has traded as high as 28.74X, as low as 18.62X and at the median of 24.70X, as the chart below shows.

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

 


Bottom Line

The role of software is evolving. Apart from running devices and applications, its usage is expanding in managing infrastructure. Moreover, the industry is benefiting significantly from the ongoing cloud transition. Further, as more and more people work remotely due to the coronavirus outbreak, demand for voice and video communication software as well as productivity software is expected to jump exponentially.

Here we present a couple of stocks with a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

These stocks are well positioned to grow in the near term.

Burlington, MA-based Avid Technology (AVID) develops, markets, sells and supports software, hardware and integrated solutions for video and audio content creation, management and distribution. The Zacks Consensus Estimate for 2020 earnings has been steady at 86 cents per share in the past 30 days.

Price and Consensus: AVID

 



Pittsburgh, PA-based Smith Micro Software (SMSI) develops and sells software to enhance mobile experience for wireless service providers and cable multiple service operators worldwide. The consensus mark for 2020 earnings stayed at 38 cents per share over the past 30 days.

Price and Consensus: SMSI

 




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