The near-term prospects of the Zacks Business-Software Services industry participants are likely to be hurt as organizations push back their investments in big and expensive technology products amid the current macroeconomic challenges and geopolitical tensions. Still-high interest rates and protracted inflationary conditions are major headwinds. These, along with elevated operating expenses related to hiring new employees and sales and marketing strategies to capture more market share, are expected to strain margins in the near term.
Despite these headwinds, the industry’s future remains bright, supported by the persistent push for digital transformation and cloud adoption, ensuring continued growth in business software and services demand. Businesses across various sectors are automating processes and managing increasing volumes of enterprise data, driving the need for advanced software and services. There’s a notable rise in demand for hybrid operating solutions and robust cybersecurity applications to combat sophisticated cyber-attacks. Companies like MSCI MSCI, Cognizant Technology Solutions CTSH, Tyler Technologies TYL and Guidewire Software GWRE are reaping the benefits of these trends.
Industry Description
The Zacks Business-Software Services industry includes companies providing specialized software products and services, available as either licensed or cloud-based applications. These solutions cover areas such as finance, sales and marketing, human resources and supply chain management. The industry features a diverse range of offerings, including business processing, consulting, application development, testing, maintenance, office productivity suites, systems integration, infrastructure services and network security applications. Some companies also offer investment-decision support tools. Key end markets for these services include manufacturing, retail, banking, insurance, telecommunications, healthcare, and the public sector.
5 Trends Shaping the Future of the Business-Software Services Industry
Transition to Cloud-Creating Opportunities: The shift from legacy platforms to modern cloud-based infrastructure is fueling demand for multi-cloud-enabled software solutions. Companies in this industry are integrating artificial intelligence (AI) into their applications to enhance dynamism and results. By offering both cloud-based and on-premise versions of their solutions, they expand content accessibility and provide enhanced interoperability, which boosts efficiency and differentiation for customers.
Subscription Model Gains Traction: To align with clients’ evolving needs, industry participants are increasingly adopting subscription and term license-based revenue models, moving away from traditional upfront payment models. Subscription-based models offer greater revenue visibility and higher recurring revenues, benefiting companies in the long term. However, this transition might slow top-line growth as subscription revenues are recognized more gradually compared to upfront term-license payments.
Continuous M&A to Expand Product Offerings: Frequent mergers and acquisitions are a common strategy among industry players to offer complementary and comprehensive software products. While these investments in digital offerings and acquisitions can enhance product portfolios, they might also impact profitability in the near term.
Macroeconomic Headwinds May Impact IT Spending: Uncertain macroeconomic conditions and geopolitical issues may lead enterprises to delay significant IT investments. Amid current economic challenges, organizations are likely to conserve cash and reduce spending, which could negatively affect the business software services market in the short term.
Elevated Operating Expenses to Hurt Profitability: To stay competitive, companies are heavily investing in research and development to broaden their capabilities and enhance their product portfolios. Additionally, significant investments in sales and marketing, including expanding sales teams, are necessary to capture more market share. These elevated operating expenses may impact profit margins in the short term.
Zacks Industry Rank Indicates Bleak Prospects
The Zacks Business-Software Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #172, which places it in the bottom 31% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all member stocks, indicates dim 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.
The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of the negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s earnings growth potential.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Underperforms the S&P 500 and the Sector
The Zacks Business-Software Services industry has underperformed the S&P 500 Index as well as the broader Zacks Computer and Technology sector’s performance over the past year.
The industry has soared 20.9% during this period, while the broader sector and the S&P 500 have increased 38.5% and 25%, respectively.
One-Year Price Performance
Industry’s Current Valuation
Comparing the industry with the S&P 500 composite and the broader sector on the basis of the forward 12-month price-to-earnings, which is a commonly used multiple for valuing business-software services stocks, we see that the industry’s ratio of 27.09X is higher than the S&P 500’s 22.01X but slightly lower than the sector’s 28.77X.
Over the last five years, the industry has traded as high as 36.71X and as low as 20.53X and recorded a median of 25.48X, as the charts below show.
F12M Price-to-Earnings Ratio (Industry vs. S&P 500)
F12M Price-to-Earnings Ratio (Industry vs. Sector)
4 Stocks in Focus
MSCI: The company offers investment decision support tools, including indexes, portfolio construction and risk management products and services, Environmental, Social and Governance (“ESG”) research and ratings and real estate research, reporting and benchmarking offerings.
MSCI’s prospects are benefiting from the strong demand for custom and factor index modules, recurring revenue business models and the growing adoption of its ESG and Climate solutions in the investment process. MSCI’s expanding portfolio of real asset solutions is noteworthy. Acquisitions, including Trove and Fabric, have strengthened MSCI’s portfolio offerings. Trove’s addition makes it the leading provider of global intelligence on carbon credit. Fabric makes it easier to deliver customization at scale for wealth managers. Strong traction from client segments like wealth management, banks and hedge funds is an upside.
The Zacks Consensus Estimate for MSCI’s 2024 earnings has moved a penny north to $14.67 per share over the past 30 days. Shares of this Zacks Rank #2 (Buy) company have decreased 11.4% year to date (YTD). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Price and Consensus: MSCI
Cognizant: It is a leading professional services company. Its services include digital services and solutions, consulting, application development, systems integration, application testing, application maintenance, infrastructure services and business process services.
Cognizant is benefiting from a robust product pipeline that includes a favorable mix of new opportunities. Acquisitions are contributing to top-line growth. Improved attrition rate bodes well for Cognizant. Continued strength among logistics, utility, travel and hospitality customers is a plus. Its strong momentum in securing large deals is a major positive. An expanding clientele due to growing partnerships with companies like Microsoft, NVIDIA, Shopify, Alphabet, McCormick & Company and Telstra has been a tailwind. It expects the NextGen initiative to help expand margins in the long haul.
CTSH stock, which currently carries a Zacks Rank #3 (Hold), has fallen 4.1% YTD. The consensus mark for 2024 earnings has remained unchanged at $4.61 per share in the past 60 days.
Price and Consensus: CTSH
Tyler Technologies: This Zacks Rank #3 company is a leading provider of integrated information management solutions and services to the public sector. Tyler serves its customers both on-premise and in the cloud.
Tyler is benefiting from higher recurring revenues, post-acquisition contributions of NIC and the rebound of market and sales activities to pre-COVID-19 levels. The public sector’s ongoing transition from on-premise and outdated systems to scalable cloud-based systems is an upside. The growing hybrid working trend is also driving the demand for its connectivity and cloud services. Its strong liquidity position is helping it pursue acquisitions, which are expected to continue to drive growth.
Shares of this Plano, TX-based company have soared 24.6% YTD. The Zacks Consensus Estimate for 2024 earnings has been revised upward by 4 cents to $9.19 per share over the past 60 days.
Price and Consensus: TYL
Guidewire Software: This San Mateo, CA-based company is a provider of software solutions for property and casualty insurers. The company’s solutions aid in reducing risks via increased productivity, bringing speed to market, digital engagement and simplifying the IT infrastructure.
Guidewire is gaining from solid Tier-1 deal volume and increasing migration activity, especially in the Asia-Pacific. Guidewire Cloud gained momentum with eight cloud deals in the third quarter of fiscal 2024. Margin performance is powered by cloud infrastructure efficiency. Also, a solid balance sheet and a robust SI partner ecosystem are major tailwinds. The company is likely to benefit as insurers modernize their legacy mainframe systems and replace previously modernized on-premise systems. Also, GWRE’s share repurchase program is noteworthy. Strategic acquisitions and collaborations, along with a less competitive market and a strong liquidity position, bode well.
This Zacks Rank #3 stock has risen 29.5% in the YTD period. The consensus mark for fiscal 2024 earnings is pegged at $1.24 per share, revised 3 cents upward over the past 30 days.
Price and Consensus: GWRE
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MSCI Inc (MSCI) : Free Stock Analysis Report
Cognizant Technology Solutions Corporation (CTSH) : Free Stock Analysis Report
Guidewire Software, Inc. (GWRE) : Free Stock Analysis Report
Tyler Technologies, Inc. (TYL) : Free Stock Analysis Report
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