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Computer Software Stock Outlook: Growth Prospects Solid

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, application performance monitoring, among others.

A few companies also provide operating systems including open-source software. There are others who offer virtualization and networking solutions. A couple of companies also 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 three major industry themes:

  • The software industry is benefiting from continued strong digital transformation environment. The last few years have witnessed a series of breakthroughs in cloud computing, predictive analysis, AI, digital personal assistants, and IoT, which set the stage for strong growth. The near-term growth 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 presents significant growth opportunity for industry players. Notably, cloud offers a flexible and cost-effective platform to develop and test new applications and the deployment time is also much shorter compared with legacy systems. SaaS companies are expected to register strong top-line growth due to 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 ultimately 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.


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 #79, which places it in the top 31% 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. In the past year, the industry’s earnings estimate for the current year has increased by almost 2.5%.

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 30.2% over this period compared with the S&P 500’s rise of 6.6% and the broader sector’s increase of 7.2%.

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 28.29X compared with the S&P 500’s 17.48X. It is also above the sector’s forward-12-month P/E of 20.83X.

Over the last five years, the industry has traded as high as 28.29X, as low as 23.27X and at the median of 26.28X, 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.

Here we present four stocks that either have a Zacks Rank #1 (Strong Buy) or 2 (Buy).

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

Progress Software (PRGS): The stock of this Bedford, MA-based business applications developer has increased 18.1% over the past year. The Zacks Consensus Estimate for fiscal year 2019 earnings per share has increased 1.2% over the past 30 days to $2.54. Progress Software sports a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: PRGS

 


Rosetta Stone (RST): The consensus mark for 2019 earnings of this Arlington, VA -based education software provider has remained steady at a loss of 60 cents over the past 30 days. This Zacks Rank #1 stock has rallied 53% in a year’s time.

Price and Consensus: RST

 


Microsoft (MSFT): The stock of this Redmond, CA-based Azure cloud and Windows operating system provider has gained 33.8% over the past year. The Zacks Consensus Estimate for fiscal 2020 earnings per share has increased 2.2% over the past month to $5.21. Microsoft has a Zacks Rank #2.

Price and Consensus: MSFT

 


Cadence Design Systems (CDNS): The stock of this San Jose-based electronic product designing solutions provider has climbed 73.8% over the past year. The current year Zacks Consensus Estimate for earnings for this Zacks Rank #2 stock has increased 2.4% over the past 30 days to $2.15.

Price and Consensus: CDNS

 


 

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Rosetta Stone (RST) : Free Stock Analysis Report
 
Progress Software Corporation (PRGS) : Free Stock Analysis Report
 
Microsoft Corporation (MSFT) : Free Stock Analysis Report
 
Cadence Design Systems, Inc. (CDNS) : Free Stock Analysis Report
 
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