Software Growth Stocks To Buy As Digital Transformation Drives Growth | Investor’s Business Daily

The big sell-off in software stocks subsided in mid-March. But as earnings for the April-May quarter start rolling in, software growth stocks are falling again.

Meanwhile, a closely watched software benchmark – iShares Expanded Tech-Software ETF (VIG) contracted 26% in 2022. The IGV index fell 13% in April, marking the worst month since October 2008, a Cowen report noted.

This year’s big sell-off in tech stocks has left many software and internet companies struggling with stock-based compensation issues which could potentially affect revenues.

On the positive side, private equity firms have been active in buying public software companies in 2022. Companies bought this year include Citrix, Anaplan, CDK and SailPoint.

Still, software stock valuations have contracted significantly since November. Software growth stocks that traded at the highest multiples of forward-looking earnings were the hardest hit.

“While valuations may have bottomed, an uncertain macro environment (higher inflation combined with war) could put strong fundamentals at risk,” Jefferies analyst Brent Thill said in a note to clients.

In his note to clients, Morgan Stanley analyst Keith Weiss said, “Software as a service valuations remain under pressure. Prospects of rising interest rates and geopolitical turmoil are creating a challenging market backdrop, pushing investors to find safety in supporting available liquidity. flow.”

Software growth stocks pull back

In addition, the IBD Computer-Software Enterprise Group fell 37% from its record high on Nov. 16. Concerns about rising interest rates appeared as a headwind for software and other technology stocks.

Additionally, software vendors involved in e-commerce have been pressured by concerns about supply chain constraints. Additionally, businesses that have benefited from work-from-home trends during the Covid pandemic are experiencing slower growth as the economy normalizes.

The big question for software growth stocks: Which companies will gain popularity during Nasdaq volatility?

BMO Capital Markets analyst Keith Bachman says profit margins are key.

“We understand that isolating one variable to assess stock performance is overly simplistic, as many factors play a role, including valuation, expectations, billing and ARR performance, among others,” he said. in a note. “Given rising interest rates, we believe margins and free cash flow will either retain or gain importance in influencing valuation for the remainder of 2022. We do not view this as a passing trend. Over the past 5-10 years, the market has rewarded “land grab” strategies in which growth has been heavily favored over earnings or FCF.”

Growth in free cash flow, a plus?

Amid the jolt in software growth stocks, some analysts backed away from the companies most exposed 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 analysts favor software stocks that generate more free cash flow. “We believe there is better valuation support with higher FCF multiples in a rising interest rate environment,” said a report from RBC Capital.

Software publishers remain one of the sectors that offers the best revenue growth in technology. Rising business spending on cloud computing, digital transformation, big data analytics, and artificial intelligence are all driving software stock revenue growth.

Additionally, the software stocks with the highest percentage of recurring revenue based on subscriptions stand out. They are known as software as a service or SaaS actions.

Software growth stocks soared in 2020

The decline in software stocks followed stellar gains. For all of 2021, the IGV software index gained 12.3% versus the nearly 27% lead of the S&P 500. In 2020, the software index climbed nearly 52% from compared to the 16.3% gain in the S&P 500. Software stocks also outperformed in 2019 and 2018.

Investors should watch the IBD stock of the day, which gives readers a detailed insight into a company’s technical and fundamental performance.

Companies featured as the IBD stock of the day included Datadog (DDOG), Paycom Holdings (PAYC) and HubSpot (HUBS).

As it is, Microsoft (MSFT) lost the IBD rating. the Ranking is IBD’s curated list of top stocks that stand out on technical and fundamental metrics.

Additionally, Microsoft has shifted to cloud computing and software as a service.

No software growth stocks currently belong to the IBD 50 List of Fast Growing Companies. Software companies that at some point joined the IBD 50 included Adobe systems (ADBE), ServiceNow, Working day (WDAY) and Atlasian.

Adobe sells digital media and marketing software. ServiceNow’s self-service technology portal provides enterprise employees with access to administrative and workflow tools. Founded in Sydney in 2002, Atlassian sells project management and collaboration software for software developers and IT engineering teams.

Software Inventories: Key Technical Notes

When deciding if the time is right to buy software stocks, Relative Strength Ratings are important. They are available on IBD Stock Check.

Additionally, investors should look for software stocks with Composite ratings above 90. IBD’s composite rating looks at both technical and fundamental factors. These factors include relative price performance, earnings growth and return on equity. (RCMP) is one of the SaaS actions that generate free cash flow. An impacting factor RCMP inventory is the recently acquired Slack Technologies integration. is a subscription-as-a-service leader. SaaS enterprise customers purchase renewable subscriptions, rather than one-time software licenses. Additionally, customers receive automatic software updates via the web.

Among the big losers so far in 2022 is Twilio (TWLO). Twilio’s tools allow application developers to integrate voice, text messaging and video into their products. Other laggards include HubSpot, Shopify (STORE), Asana (ASAN) and Coupa Software (KICK).

Amid Covid-19, the demand for next-generation collaboration and productivity tools has increased as businesses transition to work-from-home arrangements. Additionally, the pandemic has forced some companies to digitize customer-facing functions for the first time.

Additionally, cloud computing, digital transformation and artificial intelligence projects must remain the company’s priorities, according to analysts.

IBD groups together software publishers as corporate stocks as well as in vertical markets such as finance 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.

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