Software stocks take a pound as new year begins

Software stocks take a pound as new year begins

The investors fear higher interest rates, inflation and other headwinds will blunt tech spending in the new year, but some analysts think the pullback will be a buying opportunity, which has hit cloud computing and software-as-a-service stocks hard.

Software stocks have taken a pound as the new year has arrived, with analysts from JP Morgan saying that large gains in recent years have led to the stocks reaching proper valuations when growth is expected in the near future. Both the First Trust Cloud Computing ETF SKYYY, which follows Software-as - a-Service, or SaaS, stocks, and the iShares Expanded Tech-Software Sector ETF IGV, are down about 10% in the past three months, and are only showing low single-digit percentage gains in the past 12 months.

The S&P 500 index SPX is up 6% over the past three months, while the tech-heavy Nasdaq Composite Index COMP is up 2%, and the S&P 500 is up 23% and the Nasdaq is up 14% over the past 12 months.

Other analysts have followed the declines by offering their silver linings in the cloud decline - software stocks for investors to target. Jefferies analyst Brent Thill stated in a recent note that fundamentals are still alive and that valuations are stretched in the software sector. While the IGV only gained 12% compared to the S&P 500's 27% rise in 2021, that is the software ETF's 52% surge in 2020 compared to the S&P 500's 16% gain.

Multiples will continue to compress in 22 as digital digestion happens post flu and 80% of software names are expected to decelerate compared to 43% in 2021 and 66% in 2020 Thill said. We expect the IGV to surpass the S&P 500 in 22, driven by strong fundamentals after underperforming in 21. The top picks from Jefferies include Microsoft Corp. MSFT, Adobe Inc. ADBE, Inc. CRM, Inuit Inc., Palo Alto Networks Inc. PANW, CrowdStrike Holdings Inc. CRWD, and SailPoint Technologies Holdings Inc.

RBC Capital Markets said in a note by Matthew Hedberg that it doesn't expect the trend of more experiences becoming digitally connected to slow down.

Our fundamental thesis remains the same: 2020 21 changed the technology landscape in a way that will influence the next decade of tech trends and push every organization Faster to the Future, according to RBC.

Hedberg said that while initial COVID work-from- home tailwinds begin to fade and the sector faces more challenging comps, we look at the durability of software trends that will continue over the next year and decade with a focus on cloud, hybrid-work, automation, AI and security transformations.

These tech stocks have fallen as much as 51%. The durability surpasses the November December sell down due to the fears of the Omicron COVID variant, slowing COVID-related WFH tailwinds, difficult comps, sector rotations, FX headwinds, margin pressure from labor shortages and COVID-related cost savings fading, as well as overall valuation fears weigh on the sector, according to RBC.

As one of its top picks for 2022, RBC counts stocks such as Palo Alto Networks, CrowdStrike, ServiceNow Inc., Twilio Inc. TWLO, Veeva Systems Inc. VEEV, and Coursera Inc. COUR.

Mizuho analyst Siti Panigrahi said it was unsurprising that SaaS stocks have languished because of expected interest rate hikes, and that sets up an ideal buy opportunity.

After the group's valuation falls below its two-year rolling average support level, a dynamic that has not been seen since March 2020 after COVID 19 s initial shock, Panigrahi said that this underperformance makes promising SaaS stocks appear more compelling.

Palo Alto Networks, Atlassian Corp., and others are some of the top picks at Mizuho. ADSK,TEAM, Intuit, Twilio and Autodesk Inc.

UBS analyst Karl Keirstead has a more cautious view on the sector, because he called it a pattern of skinny 3 Q beats in earnings reports, and downgraded Salesforce and Adobe to hold ratings.

Keirstead spoke to more than 25 large enterprise IT executives on their spending outlooks for 2022 and came away from that with concerns that front-office spending growth may moderate in 2022, he said. Keirstead said that the risk continues to weigh on the sector in Q 21 and possibly for at least several more quarters, because of the fact that a slower pace of enterprise spending is at least partly responsible for the uninspiring results across the software sector in recent months and that the selloff could be related to inflation and the prospect of higher interest rates. In talks with IT execs, Keirstead said beneficiaries in the year 2022 appear to include companies such as Microsoft, Inc's AMZN, AWS public cloud service, MongoDB Inc. MDB, and Snowflake Inc. of the stocks covered in the report, while shares of Twilio, Veeva, CrowdStrike, SailPoint, and Autodesk have lagged 15% or more.