The Zacks Business-Software Services industry is benefiting from increased demand for digital transformation and the continued shift to the cloud. Increasing automation of business processes across multiple industries and rapidly increasing enterprise data volumes are also driving demand for enterprise software and services. The growing demand for solutions that support hybrid operating environments is remarkable. Increasingly sophisticated cyber attacks are driving demand for cybersecurity applications. Robust IT spend on software is a benefit to industry participants. Industry participants like it MSCI (MSCI – Free report), Cognizant Technology Solutions Corporation (CTSH – Free report), Tyler Technologies (tulle – Free report) and Guidewire software (THREAD – Free Report) benefit from these trends.
However, increased geopolitical risks, still high interest rates and persistent inflation are creating major headwinds. Higher operating costs related to hiring new employees and sales and marketing strategies to capture more market share are likely to put pressure on margins in the near term.
Industry description
The Zacks Business-Software Services industry primarily includes companies that provide application-specific software products and services. The applications are usually license-based or cloud-based. The offering generally includes applications in areas such as finance, sales and marketing, human resources and supply chain. The industry consists of a wide range of companies offering a wide range of products and services, including business processing and consulting, application development, testing and maintenance, office productivity solutions, systems integration, infrastructure services and network security applications. Some companies offer tools to support investment decisions. The manufacturing, retail, banking, insurance, telecommunications, healthcare and public sectors are the key end markets for industry participants.
5 trends shaping the future of the enterprise software services industry
Transition to cloud creation capabilities: Companies in this sector have benefited from robust demand for multi-cloud compatible software solutions, given the continued transition from legacy platforms to modern cloud-based infrastructure. These industry players are integrating Artificial Intelligence (AI) into their applications to make them more dynamic and results-oriented. Most industry players now offer cloud-based versions of their solutions in addition to on-premise versions, increasing the accessibility of the content. Enhanced interoperability features provide customers with differentiation and efficiency.
Subscription model gaining traction: Industry participants are adapting their business models to meet changing customer demands. Subscription and term license based pricing models have become very popular and are now replacing the old pre-payment prototype. Subscription-based business models allow for better revenue visibility and higher recurring revenue, which bodes well for businesses in the long run. However, due to this transition, the revenue growth of these companies may be affected in the coming days as licensing revenues include upfront fees, while subscription revenues will see some delays.
Continued mergers and acquisitions to expand product offering: The players in this sector regularly resort to mergers and acquisitions to deliver complementary and end-to-end software products. However, increasing investments in digital offerings and acquisitions could affect the sector’s profitability in the coming period.
Optimistic forecast for IT spending: Gartner’s latest global IT spending forecast is a benefit to industry participants. Global IT spending is expected to increase by 7.5% to $5.26 trillion by 2024. The research firm expects global software spending to grow 13.9% year-on-year by 2024.
Increased operating costs to hurt profitability: To survive in the highly competitive business software market, every player is constantly investing in broadening their capabilities. The players in the space are aggressively investing in research and development to enhance their product portfolios. In addition, companies are investing heavily to increase their sales and marketing capabilities, especially by expanding their sales force. Higher operating costs to capture more market share will likely hurt margins in the short term.
Zacks Industry Rank indicates good prospects
The Zacks Business-Software Services industry is included within the broader Zacks Computer and Technology sector. It has a Zacks Industry Rank #27, putting it in the top 11% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is essentially the average of the Zacks Rank of all member stocks, suggests a solid near-term outlook. Our research shows that the top 50% of Zacks-ranked industries outperform the bottom 50% by a more than 2-to-1 margin.
The industry’s positioning in the top 50% of Zacks-ranked industries is a result of the positive earnings outlook for its constituent companies as a whole. Looking at headline earnings estimate revisions, it appears that analysts are optimistic about this group’s earnings growth potential.
Before we present a few stocks you might consider for your portfolio, let’s take a look at the sector’s recent stock market performance and valuation picture.
Industry performs worse than S&P 500 and Sector
The Zacks Business-Software Services sector has underperformed the S&P 500 Index and the broader Zacks Computer and Technology sector over the past year.
The sector is up 31.6% during this period, while the broader sector and the S&P 500 are up 39.6% and 33.9%, respectively.
One year price performance
Current valuation of the sector
Comparing the sector to the composite S&P 500 and the broader sector based on the trailing-twelve-month price-to-earnings ratio, a common multiple for valuing enterprise software services stocks, we see that the sector’s ratio of 29.2 is equal to that of the sector. higher than the S&P 500’s 21.57 and the sector’s 25.99.
Over the past five years, the sector has traded at a high of 36.71x and a low of 20.53x, trading at a median of 25.95x, as the charts below show.
4 Business-Software Services Stocks in Focus
MSCI: The company provides tools to support investment decisions, including indexes, portfolio construction and risk management products and services, environmental, social and governance (“ESG”) research and assessments, and real estate research, reporting and benchmarking.
MSCI’s prospects benefit from strong demand for custom and factor index modules, recurring revenue business models and increasing adoption of its ESG and climate solutions in the investment process. MSCI’s growing portfolio of real asset solutions is remarkable. The company’s strategic partnerships, including with Moody’s, expanded its ESG and sustainability coverage, while the new MSCI AI Portfolio Insights tool and recent acquisitions such as Foxberry strengthened its capabilities in custom indexing and AI-driven analytics . The strong attraction of customer segments such as asset management, banks and hedge funds is an advantage.
Shares of this Zacks Rank #2 (Buy) company are up 4% year to date (YTD). The Zacks Consensus Estimate for 2024 earnings has moved a penny north over the past 60 days to $14.79 per share. You can see it You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Tyler Technologies: This Zacks Rank #2 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 benefits from higher recurring revenues, post-acquisition contributions from NIC, and the recovery of market and sales activity to pre-COVID-19 levels. The public sector’s continued transition from on-premise and legacy systems to scalable cloud-based systems is an advantage. The growing trend of hybrid working also drives the demand for connectivity and cloud services. The strong liquidity position helps the company pursue acquisitions, which are expected to continue to drive growth.
Shares of this Plano, Texas-based company are up 39% YTD. The Zacks Consensus Estimate for 2024 earnings has been revised up 3 cents over the past 60 days to $9.36 per share.
Informed: It is a leading company in professional services. The services include digital services and solutions, consulting, application development, system integration, application testing, application maintenance, infrastructure services and business process services.
Cognizant benefits from a robust product pipeline that includes a favorable mix of new opportunities. Acquisitions contribute to revenue growth. Improved churn bodes well for Cognizant. Continued strength among logistics, utility, travel and hospitality customers is a plus. The strong momentum in winning large deals is a major advantage. A growing customer base thanks to expanding partnerships with companies such as Microsoft, NVIDIA, Shopify, Alphabet, McCormick & Company and Telstra has had the wind at its back. It expects the NextGen initiative to help boost margins in the long term.
CTSH, which currently carries a Zacks Rank #3 (Hold), is up 1.3% YTD. The consensus 2024 earnings figure has been revised down by a penny over the past 30 days to $4.62 per share.
Guidewire software: This San Mateo, CA-based company is a provider of software solutions for property and casualty insurers. The company’s solutions help reduce risk through increased productivity, speed to market, digital engagement and simplifying IT infrastructure.
Guidewire is benefiting from solid Tier-1 deal volume and increasing migration activity, especially in the Asia Pacific region. Guidewire Cloud gained momentum with 16 cloud deals in the fourth quarter of fiscal 2024, bringing its total number of cloud wins for the full fiscal year to 42. Margin performance is enabled by cloud infrastructure efficiency. A solid balance sheet and a robust ecosystem of SI partners are important pillars. The business will likely benefit as insurers modernize their existing mainframe systems and replace previously modernized on-premises systems. GWRE’s share buyback program is also notable. Strategic acquisitions and collaborations, together with a less competitive market and a strong liquidity position, bode well.
Shares of this Zacks Rank #3 company are up 67.1% year-to-date. The consensus earnings estimate for fiscal 2025 is set at $1.97 per share, revised upward by 2 cents over the past seven days.