The software industry is at the forefront of the digital transformation of our society and economy. Software is being used in almost every device we interact with daily. Without it, our digital world would simply not be able to run.
This increased importance of software has led to strong stock performance. The iShares Expanded Tech-Software Sector ETF (IGV), which tracks the software industry, is up 81.5% since its March 2020 low. While the industry has seen a few pullbacks since October, the future still looks bright. Not only has software revenue accelerated over a recessionary period, information technology (IT) budgets and software spending typically rise in an economic recovery.
While many investors have been focused on more cyclical industries as of late, the digital transformation is not slowing down anytime soon, which is great news for software stocks. That’s why we’re recommending Microsoft Corp. (MSFT), Adobe Inc. (ADBE), Salesforce.com Inc. (CRM), F5 Networks, Inc. (FFIV), Autodesk Inc. (ADSK). But first, we’ll provide an overview of the software industry.
What is Software
In its simplest terms, software is a set of instructions telling a computer to do specific tasks. Anything that runs on a computer, such as its operating system, a video game, or an app, is software.
There are three types of software: system software, application software, and network software. System software controls a computer’s internal function through an operating system. It also can control external devices such as monitors, printers, and storage devices such as USBs.
Application software directs the computer to execute specific commands by the user. That means whoever is using the software is in control of it. This typically includes applications that process data such as a word processor, a spreadsheet, or a database management tool. Network software manages communication between computers on a network.
History of Software
The idea of software was first thought of by Alan Turing in 1935 but was coined by mathematician and statistician John Tukey in 1958. Computer scientist Tom Kilburn wrote the first piece of software in 1948 at the University of Manchester in England. Kilburn and his colleague Freddie Williams had created one of the earliest computers, and they programmed it to perform mathematical calculations using machine code instructions.
Much of the earliest software in the 1950s were simple punch-card programming services, but once computers were sold in mass quantities to the government, universities, and businesses in the 1960s, the demand for more advanced software increased. This resulted in software such as operating systems and other types of programs.
The next step forward was in the 1970s and 1980s when the personal computer arrived. This changed the industry as now both the individual consumer and businesses both needed different types of software. Many types of programs could now fit on floppy disks and be given to users to insert into their computers. This saw the introduction of Microsoft (MSFT – Rated “B” – Buy) Windows and Apple (AAPL) II.
In the early 1990s, we saw the first smartphone with the IBM (IBM) Simon. The sales of personal digital assistants (PDAs) required a new type of mobile software. More advanced software came with the Blackberry (BB) 850 in 1999 and the iPhone in 2007.
Today, software is everywhere. It’s not only in every smart device; it’s in your Keurig coffee machine, your car, and even your watch.
Present and Future
As the internet becomes an even bigger part of our lives, software will play an integral role in our daily tasks. The transition to the cloud has drastically changed how businesses and people interact through software. Soon all programs and files will be transferred through the cloud, and software is vital to this process.
Ten years ago, we would buy a piece of software, install it on the computer and occasionally get updates until the new and better version was available. The trend now is in Software as a Service (SaaS). Many companies are moving their software applications to subscription models, providing companies a more reliable source of revenue and making sure end customers always have up-to-date software. This is especially crucial due to the rise of malware.
The industry should continue to benefit from the key secular trends of digital transformation and cloud computing migration. This is why I’m highlighting five software stocks that I believe offer the best potential for gains in 2021.
Software Stocks to Buy in 2021
Microsoft Corp. (MSFT)
MSFT is one of the most well-known software companies in the world. The company transformed the computer industry with its Windows operating system and Office Suite. It has now transformed itself into a cloud provider with its Azure platform and its software products through a SaaS model. MSFT also sells hardware such as its Surface PCs and Xbox gaming system.
The company is poised to benefit from the continued adoption of its Azure cloud infrastructure platform, its cloud-based Office 365 productivity suite, and games it sells for the Xbox. MSFT is as well-positioned as any company to gain from the digital transformation. The cloud is widely considered the future of enterprise computing, and Azure is one of the leading cloud services. MSFT has a monopoly in software systems and applications for PCs with Windows and Office that serve as additional revenue drivers.
The stock has an overall grade of B, which translates into a Buy rating in our POWR Ratings system. The stock has a Stability Grade of B, which means its growth and price-performance are stable. MSFT also has a Sentiment Grade of B, indicating the stock is well-liked by analysts. According to the StockNews Price Target feature, 35 out of 38 analysts have a Buy or Strong Buy Rating.
We also grade MSFT based on Growth, Value, Momentum, and Quality. You can find those grades here. MSFT is ranked #12 in the Software – Application industry. You can find other top-ranked stocks in that industry here.
Adobe Inc. (ADBE)
Another well-known software company is ADBE. Almost anyone who uses a computer is familiar with a PDF file, and nearly every PC has some level of Adobe installed. The company makes software that is used for content creation, document management, and digital marketing. Its end-users include creative professionals, designers, developers, and enterprises.
In addition to the Adobe Reader, its flagship product is the Adobe Creative Suite, including Photoshop, Acrobat, Illustrator, and many more. While the company is the dominant player in content creation software, it is expanding its offerings to marketing services with its digital experience segment. This segment is expected to drive growth going forward. The shift to subscriptions not only eliminates piracy but provides a consistent revenue stream.
ADBE has an overall grade of B or a Buy rating in our POWR Ratings system. It also has a Quality Grade of A, which means it has a healthy balance sheet. ADBE has a current ratio of 1.3, which indicates it has enough cash to handle short-term obligations. The company is also highly profitable with a whopping 40.7% net margin. Like MSFT, ADBE is positively viewed by Wall Street Analysts as it has a Sentiment Grade of B. Its average analyst price target indicates a potential upside of 18%.
To access ADBE grades in Growth, Value, Momentum, and Stability, click here. ADBE is ranked #26 in the Software – Application industry.
Salesforce.com Inc. (CRM)
As previously mentioned, the software industry is moving towards a subscription model, and we can thank CRM for that. CRM introduced us to this type of business model. The company provides on-demand customer relationship management services to businesses. Its offerings include sales, service, marketing, commerce, analytics, and AI.
The company started with customer relationship offering and expanded with its Service Cloud for customer service applications and Marketing Cloud for marketing automation solutions. It has expanded further to include e-commerce, analytics, and artificial intelligence. The company also offers a platform as a service (PaaS) for developers to build applications. CRM has been benefiting from increased demand for its products due to the digital transformation.
CRM is rated a Buy and has an overall grade of B in our POWR Ratings service. It also has a Growth Grade of B due to its exponential growth. Over the past three years, earnings rose an average of 90.9% and are expected to grow 25% in the current quarter. CRM also has a Quality Grade of B due to a strong balance sheet.
In the most recent quarter, the company had $12 billion in cash, up from $9.5 billion in the previous quarter. To get a complete picture of CRM’s grades (Value, Momentum, Stability, and Sentiment), click here. CRM is ranked #17 in the Software – Business industry. You can find more top picks in that industry here.
F5 Networks, Inc. (FFIV)
FFIV is a market leader in the application delivery controller market. The company sells products for networking traffic, security, and policy management. Its application, delivery, and networking products improve the performance, availability, and security of applications running on networks that use the Internet Protocol (IP). The company ensures that applications are safely routed efficiently within on-premises data centers and across cloud environments.
FFIV is positioned to benefit from the growth potential of the application networking market as companies cope with the increasing capacity and security demands of next-gen applications. For instance, the company has a strong market position in the Layer 4-7 content switching market. It also holds a dominant position in the application delivery controller market, where its products are essential for data center consolidation and cloud services.
The company has an overall grade of B, translating into a Buy rating in our POWR Ratings system. FFIV has a Value Grade of A due to its low valuation. For instance, the company has a forward P/E ratio of 17.61, and both its price-to-sales and price-to-book ratios are below the industry averages. The company also has a Quality Grade of A due to rock-solid financials.
FFIV sports a gross margin of 81.3% and a low debt-to-equity ratio of only 0.4. For the rest of FFIV’s grades (Growth, Momentum, Stability, and Sentiment), click here. The company is ranked #12 in the Software – Business industry.
Autodesk Inc. (ADSK)
ADSK is an application software company that serves industries in architecture, engineering, and construction. Its software enables the design, modeling, and rendering needs of these industries. In fact, the company is considered the global industry-standard for computer-aided design software as millions rely on its software to design and model buildings, manufacture products, and animated films and video games.
Similar to the other companies on this list, ADSK has also moved to a subscription model. This should bring on more customers who were previously using pirated versions of its software and extract greater revenue per user. The company has driven revenue through relationships with higher-education programs that expose professionals to its software. Once introduced to the software, these professionals are much more likely to use it when entering the workforce.
ADSK is rated a Buy, with an overall grade of B in our POWR Ratings system. It also has a Quality Grade of A, indicating a healthy balance sheet. As of the most recent reporting quarter, the company had $1.9 billion in cash and no short-term debt. The company also has a Sentiment Grade of B as it is well-liked by analysts. Fifteen analysts currently rate the stock a Strong Buy or Buy.
Click here to see the rest of ADSK’s grades (Growth, Value, Momentum, and Stability). ADSK is ranked #14 in the Software – Business industry.
About the Author: David Cohne
David Cohne has 20 years of experience as an investment analyst and writer. He is the Chief Value Strategist for StockNews.com and the editor of POWR Value newsletter. Prior to StockNews, David spent eleven years as a consultant providing outsourced investment research and content to financial services companies, hedge funds, and online publications. David enjoys researching and writing about stocks and the markets. He takes a fundamental quantitative approach in evaluating stocks for readers. More...
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