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 synopsys SNPS, Cadence Design Systems CDNS and DecisionPoint Systems (DPSI).

Industry Description

The Zacks Computer Software industry includes companies that provide software applications related to cloud computing, electronic design automation (mostly 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 among others. Some develop companies and market simulation software (like computer-aided design or CAD, 3D modeling, product lifecycle management or PLM, data orchestration and experience creation), which are used by engineers, designers and researchers across various 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 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 cyber-attacks and hacking incidents 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 is fueling demand for enterprise communication, workspace management and human capital management software solutions, among others. However, global macroeconomic weaknesses along with geopolitical instability in Europe due to the ongoing Russia-Ukraine war and lingering global supply chain troubles remain 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 Dim Prospects

The Zacks Computer Software industry is housed within the wider Zacks Computer And Technology sector. It carries a Zacks Industry Rank #151, which places it in the bottom 40% 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 bleak 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.

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 looking 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 25.6% over this period compared with the S&P 500 and the broader sector’s decline of 13.6% and 31.4%, respectively.

One-Year Price Performance

Industry’s Current Valuation

On the basis of forward 12-month P/E, a commonly-used multiple for valuing software companies, we see that the industry is currently trading at 23.95X compared with the S&P 500’s 16.59X. It is also above the sector’s forward-12-month P/E of 19.89X.

In the last five years, the industry has traded as high as 37.26X, as low as 22.61X and at the median of 27.80X, 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

Cadence Design Systems: Based in San Jose, CA, Cadence offers products and tools that help customers design electronic products. The company’s performance is being driven by strength across all segments owing to healthy demand for the company’s diversified product portfolio. Frequent product launches and synergies from acquisitions are expected to help the company sustain top-line growth. Cadence recently acquired OpenEye Scientific Software which is expected to improve revenues by approximately $40 million in fiscal 2023 as well as expand the company’s market reach in pharmaceutical and biotechnology market.

The company’s Palladium and Protium platform is gaining traction among clients in the hyperscale, AI/ML and server customers.

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 this Zacks Rank #1 (Strong Buy) stock. You can see the complete list of today’s Zacks #1 Rank stocks here.

In the past year, shares of Cadence have returned 2.9%. The consensus mark for the company’s 2022 earnings is pegged at $4.11 per share, up 5.7% in the past 60 days.

Price and Consensus: CDNS

DecisionPoint Systems: Laguna Hill, CA-based DecisionPoint is engaged in providing enterprise mobility and radio frequency identification technologies. The top-line performance is being driven by broad-based strength across several verticals amid global supply chain disruptions. Also, the company’s strong relationships with its OEMs and distribution partners are a tailwind.

Synergies from recent acquisitions are likely to drive DecisionPoint’s performance. The company concluded two buyouts — Advanced Mobile Group and Boston Technologies — earlier in 2022. These acquisitions boost the company’s position in the profitable transportation and direct store delivery verticals.

The consensus mark for this Zacks Rank #1 company’s 2022 earnings is pegged at 24 cents per share, up 26.3% in the past 60 days. Shares have gained 50.2% in the past year.

Price and Consensus: DPSI

Synopsys: Mountain View, CA-based Synopsys is a vendor of electronic design automation software to the semiconductor and electronics industries. Synopsys is benefiting from strong design wins owing to a robust product portfolio. Growth in the work-and-learn-from-home trend is driving demand for bandwidth. Moreover, strong traction for Synopsys’ Fusion Compiler product boosted the top line.

Growing demand for advanced technology, design, IP and security solutions is also creating solid prospects. The rising impact of artificial intelligence, 5G, the internet of things and big data is driving investments in new compute and machine learning architectures.

The consensus mark for this Zacks Rank #2 company’s fiscal 2022 earnings is pegged at $8.84 per share, up 4.4% in the past 60 days.

Price and Consensus: SNPS

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Synopsys, Inc. (SNPS) : Free Stock Analysis Report

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