The Zacks Internet Software industry is benefiting from accelerating demand for digital transformation and the continued shift to the cloud. The high demand for Software as a Service or SaaS-based solutions due to the increasing need for remote working, learning and diagnostics software has been a key driver for industry players. The growing demand for solutions that support hybrid operating environments is a key catalyst. The increasing use of AI and generative AI is boosting the prospects. The growing proliferation of Augmented and Virtual Reality devices is remarkable. Increasingly sophisticated cyber attacks are driving demand for cybersecurity applications. Fortinet FTNT Zoom communications ZM and Twilio TWLO benefits from these trends. However, increased geopolitical risks, persistent inflation and high interest rates are major headwinds.
Industry description
The Zacks Internet Software industry includes companies that offer application performance monitoring, infrastructure and application software, DevOps implementation, and security software. Industry participants provide online payment solutions, asset optimization software, security and multi-cloud application delivery, social networking, 3D printing applications and cloud content management solutions. They use the SaaS-based cloud computing model to deliver solutions to both end users and enterprises. That is why the subscription is the main source of income. Advertising is also an important source of income. Industry participants target a variety of end markets, including banking and financial services, construction, consumer packaged goods, education, energy, legal, various service providers, federal governments, and animal health technology and services.
3 trends shaping the future of the internet software industry
SaaS adoption is growing: The industry is benefiting from the continued demand for digital transformation. The growth prospects are attractive, especially due to the rapid adoption of SaaS, which offers a flexible and cost-effective application delivery method. It also reduces implementation time compared to older systems. SaaS seeks to deliver applications to any user, anywhere, anytime, and on any device. It has proven effective in meeting customer expectations for seamless communications across multiple channels, including voice, chat, email, web, social media and mobile. This increases customer satisfaction and increases retention rates, driving top rankings among industry participants. Furthermore, the SaaS delivery model has supported industry players in delivering software applications amid the coronavirus-induced lockdowns and shelter-in-place guidance. Remote working, learning and health diagnosis have also increased the demand for SaaS-based software applications.
Pay-As-You-Go model is gaining ground: The increasing customer-centric approach allows end users to perform all required actions with minimal intervention from software vendors. The pay-as-you-go model helps Internet software providers tailor their offerings to the needs of different users. The subscription-based business model provides recurring revenue for industry participants. The affordability of the SaaS delivery model, especially for small and medium-sized businesses, is another key driver. The cloud-based applications are easy to use. The need for specialized training is thus significantly reduced, reducing costs and increasing profits.
Continuous transition to the cloud creates opportunities: The growing need to secure cloud platforms amid the increasing number of cyber attacks and hacking is driving the demand for web-based cybersecurity software. As companies continue to move their on-premise workloads to cloud environments, application and infrastructure monitoring is becoming increasingly important. This increases the demand for web-based monitoring tools for performance management.
Zacks Industry Rank indicates good prospects
The Zacks Internet Software industry, placed within the broader Zacks Computer And Technology sector, has a Zacks Industry Rank #37, putting it in the top 15% of over 250 Zacks industries.
The group’s Zacks Industry Rank, which is the average of the Zacks Rank of all member stocks, indicates strong near-term prospects. Our research shows that the top 50% of Zacks-ranked industries outperform the bottom 50% by a more than two-to-one margin.
The industry’s position in the top 50% of Zacks-ranked industries is the result of a positive earnings outlook for its constituent companies as a whole. Looking at overall earnings estimate revisions, it appears that analysts are optimistic about this group’s earnings growth potential. Industry earnings estimates for 2024 have risen 8.3% since September 30, 2024.
Given the sector’s positive outlook, there are several stocks worth picking for healthy portfolio returns. However, before we present the top picks in the sector, it’s worth looking at the shareholder returns and the sector’s current valuation.
Industry beats S&P 500, Sector
The Zacks Internet Software industry has outperformed the broader Zacks Computer and Technology sector and the S&P 500 Index over the past year.
The sector has returned 51.8% over this period, compared to the S&P 500’s jump of 32.2% and the broader sector’s valuation of 37.5%.
Current valuation of the sector
Based on trailing-twelve-month price-to-sales (P/S), a commonly used multiple for valuing Internet software stocks, we see that the sector is currently trading at 3.94x, compared to the 5.81x of the S&P 500. the sector’s trailing twelve-month P/S of 7.17x.
Over the past five years, the sector has traded as high as 7.55x and as low as 1.68x, with a median of 3.5x, as the charts below show.
3 stocks to buy now
Fortinet – This Zacks Rank #1 (Strong Buy) company is benefiting from strong demand for its solutions from large enterprise customers. You can see the complete list of today’s Zacks #1 Rank stocks here.
Higher IT spending on cybersecurity is expected to help Fortinet grow faster than the security market. The focus on improving the unified threat management portfolio through product development and acquisitions has the wind at its back.
FTNT shares are up 80.9% in the past year. The Zacks Consensus Estimate for 2024 earnings has risen 9.3% over the past 30 days to $2.23 per share.
Twilio – This Zacks Rank #1 company is benefiting from accelerated digital transformations amid a growing hybrid work trend.
TWLO is gaining ground not only through a solid expansion of its existing customer base, but also through new deals with new customers thanks to its strong focus on product introduction and a go-to-market sales strategy. The ongoing cost-cutting initiatives are boosting profits and margins, which is commendable.
Twilio shares are up 54.8% in the past year. The Zacks Consensus Estimate for TWLO’s 2024 earnings is pegged at $3.64 per share, unchanged over the past 30 days.
Zoom communications – Another No. 1 company, Zoom, is gaining significant traction in the hybrid work wave, which has accelerated the need for digital transformation in enterprises.
The launch of AI-driven solutions such as Zoom Doc and Zoom AI Companion is promising. Zoom’s growing international presence is an important catalyst. The company’s freemium business model helps it quickly acquire customers, which it can later convert into paying customers.
ZM shares have returned 17.9% over the past year. The Zacks Consensus Estimate for the company’s fiscal 2025 earnings is pegged at $5.42 per share, up 1.5% over the past 30 days.
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