What fuels the top line for software growth stocks? Increased corporate spending on cloud computing, digital transformation, big data analytics and artificial intelligence all drive revenue growth for software stocks.
Many software growth stocks have pulled back from all-time highs after a big run.
They include Zoom Video Communications (ZM) and e-commerce firm Shopify (SHOP). But, software stocks are still to be found in the IBD Leaderboard as well as the IBD 50.
In addition, the Leaderboard is IBD’s curated list of leading stocks that stand out on technical and fundamental metrics.
Microsoft, Adobe Still Among Top Software Growth Stocks
ServiceNow (NOW), Microsoft (MSFT) and Adobe Systems (ADBE) hold positions on the IBD Leaderboard. ServiceNow and Adobe also belong to the IBD 50 roster of fast-growing companies.
ServiceNow’s self-service tech portal enables company employees to access administrative and workflow tools. Also, ServiceNow’s third-quarter earnings beat estimates.
Workday (WDAY), meanwhile, ranks No. 30 in the IBD 50. Workday stock reports earnings on Nov. 19.
The IBD Computer-Software Enterprise group ranks No. 83 out of 197 industry groups tracked by IBD. That’s down from No. 28 six weeks ago and No. 2 four months ago.
A closely watched software benchmark — the iShares Expanded Tech-Software ETF (IGV) — slipped 2% in October and dipped 4% in September. However, the IGV Software index is still up 38% in 2020.
Software Stocks: Earnings On Tap For Salesforce, Zoom Video, Snowflake
When deciding whether the time is right to buy software stocks, Relative Strength Ratings are important.
Cloudflare (NET) and Sprout Social (SPT) hold Relative Strength Ratings of 98 out of a possible 99. Cloudflare reported third-quarter earnings that topped expectations.
Some software growth stocks have yet to report earnings. They could give preliminary 2021 outlooks when they do.
Salesforce.com (CRM) reports third-quarter earnings on Dec. 1. Salesforce stock recently formed a double-bottom chart pattern. But CRM stock pulled back after touching an entry point.
Zoom Video stock reports Nov. 30. DocuSign (DOCU) reports on Dec. 3 while Snowflake (SNOW) reports Dec. 2.
Further, DocuSign still holds a respectable Relative Strength Rating of 96. DocuSign software digitizes contract paperwork. With business travel restricted, more companies are closing deals using electronic signatures.
However, Snowflake’s Relative Strength has dropped to 18. Snowflake’s initial public offering will be remembered for years to come. San Mateo, Calif.-based Snowflake sells cloud computing-based technology for storing and analyzing data.
With underwriters pricing Snowflake stock at 120, shares opened at 245. Also, Snowflake stock popped as high as 319 in its first day of trading and closed at 254. Snowflake stock, however, has retreated from its volatile IPO.
Software Stocks: Coronavirus Impact
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.
The shift to remote work boosted companies such as Zoom Video and Dynatrace (DT). But Zoom stock recently pulled back on positive vaccine news. Zoom stock is no longer in a buy zone.
While there’s been a correction in the sector, there’s still a bull case for software growth stocks as companies invest in digital transformation, UBS analyst Karl Keirstead in a recent note to clients.
“The enterprise software sector, specifically the cloud-centric firms, are facing what could be a once-in-a-decade demand catalyst as Covid-19 and the economic crisis shifts the mindset of large enterprises and kicks-off a multi-year technology investment cycle,” he said. “Moreover, the margin structure of software firms may now be permanently higher.”
Many software growth stocks traded at all-time high multiples of forward-looking revenue over the summer. Why the big rally? Amid a weakening economy, software growth companies offered recurring revenue streams, produced by subscription-based services.
In addition, as the economy rebounds, various types of digital transformation projects are expected to remain a budget priority.
SaaS Business Models Provide Recurring Revenue
So far, software companies catering to large companies fared better generally than those focused on small and medium-size businesses. Many software companies have relaxed payment terms, especially for customers in hard-hit industries such as travel.
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. Companies continue to shift from on-premise software offerings to applications in the internet cloud. Many analysts view SaaS stocks as the best cloud stocks.
SaaS companies make up 25% of the enterprise software market currently. ARK Invest projects that that SaaS revenues will grow at a 21% CAGR for the next decade, topping $780 billion or 80% of the enterprise software market by 2030.
The customers of SaaS companies purchase renewable subscriptions, rather than one-time software licenses. Further, customers receive automatic software updates via the web.
SaaS companies post the best revenue growth in the software sector. In addition, SaaS stocks engage in the most mergers and acquisitions. As a result, SaaS stocks trade at the highest multiples.
Salesforce.com pioneered SaaS. It holds the highest SaaS market cap.
In addition, Microsoft has pivoted to cloud computing and software-as-a-service. It was recently was featured as an IBD Stock of the Day, giving readers a close look at its technical and fundamental performance.
Software Stocks With Solid Composite Ratings
According to IBD Stock Checkup, many software growth stocks own high Composite Ratings. IBD’s Composite Rating looks at technical and fundamental factors. Those factors include relative price performance, earnings growth and return on equity.
Software stocks with Composite Ratings above 95 include ServiceNow, Five9 (FIVN), DocuSign and Zendesk (ZEN). Further, Zendesk sells customer service and marketing tools.
Zendesk’s third-quarter earnings topped expectations.
However, the Composite Ratings of some software growth stocks have dipped below 90. They include Datadog (DDOG), Twilio (TWLO) Atlassian (TEAM) and Coupa Software (COUP).
With an acquisition, Twilio is taking on bigger Salesforce.com and Adobe.
Also, Atlassian (TEAM) sells collaboration tools for software developers and tech departments. Coupa, which has pushed into artificial intelligence tools, was featured in IBD’s New America section.
Twilio‘s tools enable app developers to embed voice, text messaging and video into their products. Datadog operates a monitoring and analytics platform for software developers.
The Outlook For Software Spending
Research firm IDC forecasts that worldwide information technology spending will decline 2.7% this year as Covid-19 impacts the global economy. Spending on software is expected to rise 1.7%, compared with a 10% increase in 2019.
Cloud computing, digital transformation and artificial intelligence projects could remain corporate priorities, analysts say.
In addition, there’s a wide range of software companies to watch.
Further, 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.
Upland Software (UPLD) has been on an acquisition spree. Austin, Texas-based Upland makes cloud-based software to manage business projects and workflow.
Cambridge, Mass.-based HubSpot (HUBS) specializes in helping businesses automate marketing and sales operations. Also, its cloud-based platform assists clients in social media, search engine optimization and website content management.
In addition, there also are human-resources software stocks such as Paycom Holdings (PAYC) and Paylocity Holdings (PCTY). Paycom and others have exposure to small and medium-size businesses shut down by the coronavirus emergency.
Follow Reinhardt Krause on Twitter @reinhardtk_tech for updates on 5G wireless, artificial intelligence, cybersecurity and cloud computing.
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