Software shares are taking it on the chin, with the S&P Software & Services Select Industry Index, dropping 24% thus far this yr. So what’s occurring?
“Following a year of underperformance in 2021, the software sector has gotten off to a rocky start in 2022, as questions around rising rates and valuation levels have morphed into concerns around impacts of a potential recession,” Wells Fargo analysts wrote in a commentary.
“We remain selective with our ratings and recommendations—favoring those companies with more tangible valuation backstops and identifiable catalysts ahead, alongside vendors best able to lean into return-on-investment-based selling.”
The analysts cite three anticipated themes for this yr:
1) “Incumbent platforms reinforcing their moats—presenting an advantage for larger-cap, more established software platforms;
2) “Labor shortages creating a critical need for automation—suggesting prioritization for those vendors able to present … efficiency/productivity gains in an increasingly tight labor market;
3) “A new data paradigm coming into focus—opening up new budget [space] for data-related infrastructure, ingestion tools, and sales/marketing-focused software applications.”
The analysts additionally level to an surprising theme. “The drag on performance from a series of macro-related headwinds has presented [something] beyond what we were expecting,” they stated.
“We expect software performance will remain choppy through end of summer, with second-half results where the rubber meets the road in terms of helping quantify any macro drag on fundamentals.”
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The analysts recommend “a barbell approach to the space—core positions in large cap, defensive platforms, with selective shots on goal aimed at high-quality growth names with greater rebound potential.”
For the remainder of the yr, they provide three picks every for protection and offense.
· Microsoft (MSFT) – Get Microsoft Corporation Report. “It’s still the best way to play the broad secular trend toward software,” the analysts stated The firm’s platform positioning is “especially advantageous in the current environment,” they stated.
· ServiceNow (NOW) – Get ServiceNow Inc. Report. “It’s among the most well-positioned platforms and well-balanced financial profiles in software,” the analysts stated.
· Workday (WDAY) – Get Workday Inc. Report. “It has a series of meaningful growth drivers in motion and what we see as a favorable setup into fiscal year 2023, given the improving financial profile and defensive positioning of this platform.”
· Atlassian (TEAM) – Get Atlassian Corporation Plc Report. “Cloud transition represents a significant value-creating event for this well-positioned long-term focused company,” the analysts stated.
· HubSpot (HUBS) – Get HubSpot Inc. Report. “It has plenty of continued runway given still elevated new customer activity, record retention rates, an expanding set of products, and a steady move up-market,” the analysts stated.
· Samsara (IOT) . “It has a significant market opportunity, differentiated technology, and a favorable demand backdrop, given its safety/efficiency focus,” they stated. They count on that can “help bring investor attention back to this high-quality recent IPO.”