3 Software Stocks to Watch for in a Prospering Industry

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 continuation of remote work setup and mainstream adoption of the hybrid/flexible work model, the demand for voice and video communication and productivity software is expected to increase exponentially. These trends bode well for industry participants like Adobe ADBE, Salesforce CRM and Cadence Design Systems CDNS. However, inflationary pressure and 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. Continued investment in big data and analytics and the ongoing adoption of software as a service or SaaS opens up opportunities for industry 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. Apart from this, 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 has 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: The mainstream adoption of the distributed workforce model is fueling demand for enterprise communication, workspace management and human capital management software solutions. However, global macroeconomic weakness and volatile supply chain dynamics continue to be concerns. Increasing 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.
 

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 #46, which places it in the top 18% of more than 251 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 Apr 30, 2023, the industry’s earnings estimate for 2023 has improved by 2.5%.

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% over this period compared with the S&P 500 and the broader sector’ increase of 13.3% and 35.2%, 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 31.84X compared with the S&P 500’s 19.09X. It is also above the sector’s forward-12-month P/E of 24.45X.

In the last five years, the industry has traded as high as 37.37X, as low as 22.63X and at the median of 28.83X, 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

Adobe: San Jose, CA-based Adobe is one of the largest software companies in the world. The company picks up licensing fees from customers, which form the bulk of its revenues.

Adobe is benefiting from strong demand for its creative products. The company’s Creative Cloud, Document Cloud and Adobe Experience Cloud products are driving the top line. Rising subscription revenues and solid momentum across the mobile apps are major positives. Growth in emerging markets and robust online video creation demand remain tailwinds. Also, solid demand for Adobe’s commerce offerings and the growing adoption of Acrobat bodes well.

Adobe carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The Zacks Consensus Estimate for Adobe’s fiscal 2023 EPS has increased by 0.1% in the past 60 days to $15.93. ADBE’s long-term earnings growth rate is 13.5%.

Adobe’s earnings beat the Zacks Consensus Estimate in each of the last four quarters, the average surprise being 3.3%. Shares of ADBE have surged 85.2% in the past year.

Price and Consensus: ADBE

Salesforce: Headquartered in San Francisco, Salesforce is the leading provider of on-demand Customer Relationship Management (CRM) software, which enables organizations to better manage critical operations, such as sales force automation, customer service and support, marketing automation, document management, analytics and custom application development.

Salesforce benefits from a robust demand environment as customers are undergoing a major digital transformation. Its sustained focus on aligning products with customer needs is driving the top line. Continued deal wins in the international market are another growth driver. The acquisition of Slack positioned the company as a leader in enterprise team collaboration and improved its competitive standing versus Microsoft Teams. Salesforce’s strategy of continuously expanding generative AI offerings will help it tap the growing opportunities in the space.

Salesforce carries a Zacks Rank #2. The company’s fiscal 2024 earnings are pegged at $8.06 per share, indicating year-over-year growth of 53.8%. The long-term growth rate is pegged at 22.5%. The stock has gained 50.8% in the past year.

Price and Consensus: CRM

Cadence Design Systems: Based in San Jose, CA, Cadence offers products and tools that help customers design electronic products. Its core electronic design automation software and services enable engineers to develop different types of ICs.

Cadence’s stock price is being driven by healthy demand for its diversified product portfolio across all segments.  Owing to strong momentum, CDNS reported robust results for third-quarter 2023. It delivered non-GAAP earnings of $1.26 per share, which beat the Zacks Consensus Estimate by 4.1% and jumped 18.9% year over year. Revenues of $1.023 billion surpassed the Zacks Consensus Estimate by 1.7% and rose 13.3% on a year-over-year basis.

Management raised full-year guidance on the back of strong quarterly results. It highlighted that design activity continued to be solid due to transformative generational trends such as AI, hyperscale computing, 5G and autonomous driving. Management noted that there is an increase in the production of 3D-IC and chiplet designs, and more system companies are now building custom silicon, which bodes well. Cadence stated that its comprehensive JedAI Generative AI platform was witnessing continued traction, with sales of its GenAI solutions having nearly tripled in the last year.

The stock carries a Zacks Rank #2. The consensus mark for the company’s 2023 earnings is pegged at $5.11 per share, up 19.7% year over year. The long-term growth rate is pegged at 19.5%. Shares have gained 63.6% in the past year.

Price and Consensus: CDNS


 

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Salesforce Inc. (CRM) : Free Stock Analysis Report

Adobe Inc. (ADBE) : Free Stock Analysis Report

Cadence Design Systems, Inc. (CDNS) : Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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