3 Software Stocks to Watch for in a Challenging Industry

The Zacks Computer Software industry benefits from the pandemic-induced 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 software and productivity software is expected to increase exponentially. These trends bode well for industry participants like Cadence Design Systems CDNS, PTC PTC and Aspen Technology AZPN.

Industry Description

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-premises and cloud-based database management, accounting and tax purposes, human capital management, cybersecurity and application performance monitoring and cloud-based enterprise communications platform among others. Some of the companies specialize in developing and marketing simulation software (like the computer-aided design or “CAD”, 3D modelling, product lifecycle management or “PLM”, data orchestration and experience creation), which are used by engineers, designers and researchers across a broad spectrum of industries like architecture, engineering and construction; product design and 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 the enterprises on software procurement. Continued investment in big data and analytics and the ongoing adoption of software as a service or SaaS open up significant opportunities for industry players. Cloud offers a flexible and cost-effective platform for developing and testing applications. The deployment time is also much 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 the cloud platforms, amid growing incidents of cyber-attacks and hacking, is driving demand for cyber security software. Enterprises are focused on rapid migration to cloud and DevOps technologies to achieve scalability and agility for software development and IT operations. This helps in delivering a flawless digital experience to clients. This 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.

Mainstream adoption of Hybrid/Remote Work to Drive Demand: The continuation of work-from-home and the mainstream adoption of the distributed workforce model are fueling demand for enterprise communication, workspace management and human capital management software solutions, among others. However, the evolving coronavirus situation particularly in China and the geopolitical instability due to the Russia-Ukraine war have aggravated the already strained global supply chain troubles. 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 Dim Prospects

The Zacks Computer Software industry is housed within the broader Zacks Computer And Technology sector. It carries a Zacks Industry Rank #150, which places it in the bottom 41{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} of more than 253 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak 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.

Despite the gloomy industry outlook, a few stocks have the potential to outperform the market. But before we present the top industry picks, it is worth taking a look at the industry’s shareholder returns and current valuation first.

Industry Outperforms Sector But Lags S&P 500

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

The industry has lost 7.3{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} over this period compared with the S&P 500 and the broader sector’ decline of 7{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} and 22.4{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847}, respectively.

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 25.27X compared with the S&P 500’s 16.91X. It is also above the sector’s forward-12-month P/E of 19.61X.

In the last five years, the industry has traded as high as 37.04X, as low as 22.63X and at the median of 27.56X, as the chart below shows.

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

Forward 12-Month P/E Ratio

3 Software Stocks to Snap Up Right Now

Aspen Technology: Bedford, MA-based Aspen Technology provides asset optimization software solutions. The company’s performance is gaining from improving customer demand. Its diversified product portfolio, especially its asset optimization and management software solutions and Asset Performance Management (APM) suite, is witnessing healthy momentum. Strategic acquisitions are likely to boost the top line going forward. The integration with Emerson’s OSI Inc and the Geological Simulation Software business bodes well in the long haul.

In the past year, shares of Aspen Technology have moved up 35.3{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847}. The consensus mark for this Zacks Rank #1 company’s fiscal 2022 earnings is pegged at $5.47 per share, up 3{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} in the past 60 days. You can see the complete list of today’s Zacks #1 Rank stocks here.

Price and Consensus: AZPN

Cadence Design Systems: Based in San Jose, CA, Cadence offers products and tools that help customers design electronic products. The company is well-positioned to gain from strength across segments like digital & signoff solutions and functional verification suite. Expanding product portfolios and frequent product launches are key catalysts. In 2021, Cadence introduced 13 new products, including Cadence Helium Virtual and Hybrid Studio and Allegro X. Increasing investments in emerging trends like Internet-of-things (IoT), augmented and virtual reality (AR/VR) and autonomous vehicle sub-systems present significant growth opportunities for the company in the long haul. The recent acquisitions of Pointwise and NUMECA are expected to boost the top line.

In the past year, shares of Cadence have returned 13.5{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847}. The consensus mark for this Zacks Rank #2 company’s 2022 earnings is pegged at $3.89 per share, up 4.3{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} in the past 60 days.

Price and Consensus: CDNS

PTC: Boston, MA-based PTC provides software solutions and services globally that help manufacturing companies design, operate and manage products. The company’s top-line performance is driven by robust demand for products (digital transformation and SaaS) across all segments and regions. The company is also working toward accelerating the SaaS transition by increasing the capacity of its Atlas platform and improving its SaaS capabilities. PTC is witnessing robust adoption of Creo CAD and Windchill solutions. Strategic acquisitions have played a pivotal part in developing the company’s business in the last few years.

The consensus mark for this Zacks Rank #2 company’s fiscal 2022 earnings is pegged at $4.46 per share, up 5.4{64d42ef84185fe650eef13e078a399812999bbd8b8ee84343ab535e62a252847} in the past 60 days.

Price and Consensus: PTC