By Eric J. Savitz
After software stocks’ broad rally in 2023, it’s time for investors to get pickier.
The sector roared 58% higher last year — as measured by the closely watched i Shares Expanded Tech-Software Sector exchange-traded fund — driven by the mania over generative artificial intelligence, cost cuts, and hopes for lower interest rates.
Of course, some of those trends are still in place: The AI trend is really just starting, and companies continue to trim staff and look for ways to improve profitability. But uneven demand conditions and the unclear timing of AI’s boost to profits mean the sector’s performance could be a bit more mixed in 2024.
“Software stocks are no more expensive than a year ago, thanks to the ‘year of efficiency’ and new GenAI growth opportunities,” BNP Paribas analyst Stefan Slowinski wrote Thursday, in a long report on the software industry’s outlook. “The bad news is that demand trends are not (yet) showing any signs of improvement.”
Slowinski had exited 2023 with no Underperform-rated software stocks, but that has now changed.
The analyst is turning “slightly more defensive” on the group, citing “continued weak demand trends and near-term GenAI monetization disappointment risk.” In addition, software stocks could stumble if the Federal Reserve doesn’t lower interest rates as soon as the market expects.
On Thursday, Slowinski lowered his ratings on Adobe, Shopify, and Zoom Video Communications to Underperform from Neutral. He notes that Adobe and Shopify already trade at more than 12 times forward sales.
“Rate-cut disappointments are a risk, as is consumer discretionary spend exposure for Shopify, and increased GenAI competition for Adobe,” he writes.
As for Zoom, channel checks “call into question Zoom’s ability to deliver on the enterprise growth acceleration the market expects in 2024,” he writes.
But Slowinski is bullish elsewhere in the industry, boosting Microsoft stock to Outperform from Neutral. He sees the software giant as having “more defensive qualities,” including one of the lowest valuations in the group on a price-to-earnings basis. He also sees restructuring benefits from the integration of Activision, and potential for an earnings beat this year driven by the Azure cloud business. Free cash flow improvements in fiscal year 2025 should mark a shift from GenAI investment to GenAI returns for Microsoft.
Slowinski also maintains Outperform ratings on Oracle, Salesforce, and SAP, seeing the potential for 20% earnings-per-share growth for all three. He is still bullish on both Workday and Alphabet, and maintains Neutral ratings on Amazon.com, Intuit, ServiceNow, and Snowflake.
Microsoft shares are 0.6% higher on Thursday, while Shopify is down 0.7%, Adobe is 1.3% lower, and Zoom is down 1.5%.
Write to Eric J. Savitz at firstname.lastname@example.org