3 Network Software Stocks to Buy in a Challenging Industry

The Zacks Communication-Network Software industry is suffering from supply-chain disruption as well as a shortage of components. The macroeconomic slowdown, the ongoing Russia-Ukraine war, raging inflation and heightened price competition are hurting industry participants. Small and medium businesses have deferred capital spending on infrastructure buildout due to higher interest rates and inflation, which doesn’t bode well for industry participants. Nevertheless, companies like A10 Networks ATEN, Weave Communications WEAV and Kaleyra KLR are gaining from ongoing digitalization efforts that include a shift to cloud computing and rapid deployment of 5G-based networks. The strong demand for network security benefits industry participants as a secure environment is required to proliferate cloud-based applications.

Industry Description

The Zacks Communication-Network Software Industry comprises companies that provide software solutions supporting cloud, on-premise and hybrid environments, communication technology solutions, including broadband and Voice Over Internet Protocol (“VoIP”), digital communication services delivered as software-as-a-service and telecom solutions supporting proliferation and deployment of 5G and 6G networks of the future. There are few companies that offer solutions based on Open Radio Access Network (“RAN”) standard. Others offer wireless connectivity solutions for mission-critical Industrial Internet applications and services. Solutions from these companies support a variety of industries, including telecommunications, technology, industrial, government, retail, financial, gaming and education.

3 Trends Shaping the Future of the Communication-Network Software Industry

Increased Adoption of Cloud-based Solutions: Rapid digitalization driven by the disruption caused by the pandemic has increased demand for cloud-based applications, virtualized software and container-based software. Applications are being developed in the cloud, which is creating opportunities and, at the same time, challenges for industry participants in terms of performance and security. A rising number of cyber-attacks, including Distributed Denial of Service attacks and attacks using malware through Transport Layer Security and Secure Sockets Layer protocols, is redefining the cyber threat landscape. Enterprises are spending more on cloud-based security solutions. Moreover, the software-defined approach is increasingly getting preferred over legacy hardware-centric models due to the need for agility.

Growing Importance of Automation Tools: The ongoing rapid transition to the cloud has increased the importance of automation tools. Enterprises are adopting automated tools to deploy and operate security and application services. This is improving performance monitoring and detection, reporting security anomalies and reducing overall costs.

Rapid Evolution of 5G and 6G Networks: Industry participants are benefiting from a continued rise in demand for data-intensive bandwidth and the need for reduced latency associated with smartphones, tablets and machine-to-machine communication. The proliferation of data centers, big data, cloud-based services, streaming media content and IoT is a key catalyst. The rapid deployment of 5G networks is creating a massive growth opportunity for telecom providers who are using solutions provided by industry participants.

Zacks Industry Rank Indicates Dim Prospects

The Zacks Communication-Network Software industry is housed within the broader Zacks Computer And Technology sector. It carries a Zacks Industry Rank #143, which places it in the bottom 43{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} 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 dim near-term prospects. Our research shows that the top 50{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} of the Zacks-ranked industries outperform the bottom 50{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} of the Zacks-ranked industries is a result of the negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s earnings growth potential. Since Dec 31, 2021, the industry’s earnings estimates for the current year have moved 72{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} south.

Despite the gloomy industry outlook, a few stocks are worth watching due to their strong prospects. But before we present these stocks, it is worth looking at the industry’s shareholder returns and current valuation first.

Industry Lags Sector and S&P 500

The Zacks Communication-Network Software industry has underperformed the Zacks S&P 500 composite and its sector in the past year.

The industry is down 40{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} over this period compared with the Zacks Computer and Technology sector’s decrease of 33.1{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} and the S&P 500’s decline of 16.4{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847}.

One-Year Price Performance

Industry’s Current Valuation

On the basis of the trailing 12-month EV/Sales, a commonly used multiple for valuing network software companies, we see that the industry is currently trading at 1.65X compared with the S&P 500’s 3.30X and the sector’s 3.06X.

Over the past five years, the industry has traded as high as 3.86X, as low as 0.82X and at the median of 1.39X, as the chart below shows.

EV/Sales Ratio (TTM)

3 Stocks to Buy Right Now

A10 Networks: San Jose, CA-based A10 currently has a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

A10 is benefiting from strong demand for its networking solutions among service providers as network security and reliability are necessary. A10’s expanding partner base and portfolio strength are helping it to navigate a challenging macroeconomic environment and supply chain constraints.

The stock has gained 13.4{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} year to date. The Zacks Consensus Estimate for A10’s 2022 earnings has remained stable at 69 cents per share over the past 30 days.

Price and Consensus: ATEN

Kaleyra: This Zacks Rank #2 company provides mobile communication services to financial institutions, e-commerce players, over-the-top media providers, software companies, logistic enablers, healthcare providers, retailers, and other large organizations worldwide.

Italy-based Kaleyra has lost 88.9{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} year to date. The Zacks Consensus Estimate for KLR’s current-year loss has narrowed from $1.27 to $1.03 per share over the past 30 days.

Price and Consensus: KLR

Weave Communications: This Zacks Rank #2 company is a leading provider of all-in-one customer communications and engagement software platforms for small and medium-sized businesses.

Lehi, UT-based Weave has lost 74.7{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} year to date. The Zacks Consensus Estimate for WEAV’s current-year loss has been steady at 53 cents per share in the past 30 days.

Price and Consensus: WEAV

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