The sell-off in software stocks continues. At some point, some software growth stocks will be back in favor. But at what valuation?
Software companies still offer among the best revenue growth of technology stocks. Increased corporate spending on cloud computing, digital transformation, big data analytics and artificial intelligence all drive revenue growth for software stocks.
Further, software stocks with the highest percentage of subscription-based, recurring revenue stand out. They’re known as software-as-a-service, or SaaS, companies.
On the other hand, the valuations of software stocks have contracted significantly. Software growth stocks that traded at the highest multiples of forward-looking revenue have been the hardest hit.
Software Stocks: Worries Over Interest Rates
Consider Snowflake (SNOW) stock. San Mateo, Calif.-based Snowflake sells cloud computing-based technology for storing and analyzing data.
SNOW stock has collapsed 47% in 2022. Shares tumbled after solid fourth-quarter financials fell shy of investor expectations.
Other software stocks have retreated amid “strong fundamental prints,” said Jefferies analyst Brent Thill in a report.
“Despite commentary from management teams highlighting their belief in the fundamental strength, the stocks still headed down due to fears around the sustainability of growth as investors grapple with a rising interest rate environment,” he said.
A closely watched software benchmark — the iShares Expanded Tech-Software ETF (IGV) has contracted 22% in 2022. The IBD Computer-Software Enterprise group has retreated 46% from its all-time high set on Nov. 16, 2021.
Worries over rising interest rates emerged as a headwind to software and other tech stocks. In addition, software makers involved in e-commerce were pressured by concern over supply chain constraints.
And, companies that benefited from work-at-home trends during the Covid pandemic, such as Zoom Video Communications (ZM) and DocuSign (DOCU), are experiencing slower growth as the economy normalizes.
DocuSign stock plunged March 11 on weak guidance. Fiscal 2023 guidance for ZM stock also came in below expectations.
Software Growth Stocks Soared In 2020
The pull-back in software stocks followed stellar gains. For all of 2021, the IGV software index gained 12.3% vs. the S&P 500’s nearly 27% advance. In 2020, the software index soared nearly 52% vs. the S&P 500’s gain of 16.3%. Software stocks also out-performed in 2019 and 2018.
The big question for software growth stocks: what companies will be gain favor during volatility in the Nasdaq and longer term.
Investors should monitor the IBD Stock of the Day, which gives readers a close look at a company’s technical and fundamental performance.
Companies featured as the IBD Stock of the Day have included Datadog (DDOG), Paycom Holdings (PAYC) and HubSpot (HUBS).
As it stands, Microsoft (MSFT) belongs to the IBD Leaderboard. The Leaderboard is IBD’s curated list of leading stocks that stand out on technical and fundamental metrics.
MSFT stock has dropped 16% in 2022. In addition, Microsoft has pivoted to cloud computing and software-as-a-service.
No software growth stocks currently belong to the IBD 50 roster of fast-growing companies. Software companies that at one-time joined the IBD 50 included Adobe Systems (ADBE), ServiceNow (NOW), Workday (WDAY) and Atlassian (TEAM).
Adobe sells digital media and marketing software. ServiceNow’s self-service tech portal enables company employees to access administrative and workflow tools. Founded in Sydney in 2002, Atlassian sells project management and collaborative software for software developers and information technology engineering teams.
Software Stocks: Key Technical Ratings
When deciding whether the time is right to buy software stocks, Relative Strength Ratings are important. They’re available at IBD Stock Check-up.
Also, investors should look for software stocks with Composite Ratings above 90. IBD’s Composite Rating looks at technical and fundamental factors. Those factors include relative price performance, earnings growth and return on equity.
Amid the shake-out in software growth stocks, some analysts have steered away from companies with higher exposure to stock-based compensation. According to a Baird report, software companies with “more options underwater” amid falling stock prices have a higher risk of employee turnover.
Some analyst favor software stocks that generate more free cash flow. “We do believe there is greater valuation support with higher FCF multiples in a rising interest rate environment,” said a RBC Capital report.
Growing Free Cash Flow A Plus?
Salesforce.com (CRM) is among software stock that churn out free cash flow. One factor impacting CRM stock is the integration of recently acquired Slack Technologies.
Salesforce.com has been a leader in subscription-as-a-service. The customers of SaaS companies purchase renewable subscriptions, rather than one-time software licenses. Further, customers receive automatic software updates via the web.
Among the big losers so far in 2022 is Twilio (TWLO). Twilio’s tools enable app developers to embed voice, text messaging and video into their products. Other laggards include HubSpot, Shopify (SHOP), Asana (ASAN) and Coupa Software (COUP).
Amid Covid-19, demand for next-generation collaboration and productivity tools increased as companies shifted to work-from-home arrangements. Also, the pandemic forced some companies to digitize customer-facing functions for the first time.
Cloud computing, digital transformation and artificial intelligence projects should remain corporate priorities, analysts say.
IBD groups software companies as enterprise stocks as well as in vertical markets such as financial and medical. Also, some companies belong to product groups, such as database software and computer security.
Follow Reinhardt Krause on Twitter @reinhardtk_tech for updates on 5G wireless, artificial intelligence, cybersecurity and cloud computing.
How This IBD Tool Simplifies The Search For Top Stocks
Get A Free Trial Of IBD Leaderboard
Best Growth Stocks To Buy And Watch: See Updates To IBD Stock Lists
How To Use The 10-Week Moving Average For Buying And Selling
Source: https://www.investors.com/news/technology/saas-stocks-cloud-stocks/?src=A00220&yptr=yahoo