Software Stocks: U.S. Leads The Way

Software Stocks

The U.S. software industry is in the fast lane. While the Dow Jones index virtually stood still in the past six months, the Dow Jones U.S. Software sector index rose by 25%. Picking the correct software stocks remains the be-all and end-all.

Analyzing Software Stocks

Tech giant Microsoft (MSFT) gained more than 30% in the past half-year, clearly outperforming the Dow Jones index and additionally outperforming the sector index. Adobe Systems (ADBE) shares were also among the industry winners.

Both software stocks also still offer a reasonable ratio of stock valuation to earnings growth. An unfavorable ratio was emerging for Salesforce.com (CRM). Salesforce’s stock price performance was much weaker, barely outperforming the Dow Jones index and underperforming the S&P 500 index for the year.

Stock Valuation and Shareholder Value Approach Are Key Factors

Lush earnings and cash cushions give software companies the ability to buy back their own stock and pay higher dividends. While dividend yields tend to be low for software stocks, share buybacks provide an additional boost to share prices. The buyback and cancellation of treasury shares reduces the number of shares, which increases earnings per share and accelerates their growth.

On the other hand, it can be assumed that the stock option programs, some of which are very lavish, will continue to weigh on some share prices. Adobe and Microsoft also use stock option programs, but to a much lesser extent than Salesforce, for example. 

At Microsoft, stock option expense was 8% of net income, according to its most recent quarterly report; Adobe was 22%. At Salesforce, the ratio of stock option expense to net income was about 174% in Q3. This leads to an increasing number of shares, which dampens the share price outlook.

Positive Outlook on Software Stocks

Although the economic situation is subdued in view of the resurgent COVID-19 crisis, the market environment for software companies still appears positive. The ever-increasing importance of the Internet for businesses and consumers is also driving demand for software products.

The pandemic’s providing an additional boost with trends such as homeschooling and home office, as well as the increasing amount of free time consumers spend with end devices. Moreover, it’s likely that many companies will have the market power to raise prices further. Thus, software stocks also offer good inflation protection. I therefore remain optimistic about the sector.

Dr. Gregor Bauer
Dr. Gregor Bauer
Dr. Gregor Bauer credits his trading success to combining fundamental aspects of a trade with expert technical analysis. A Certified Financial Technician from the International Federation of Technical Analysts (IFTA), he’s rated as one of Germany’s top 300 economic experts.
Dr. Gregor Bauer
Dr. Gregor Bauer
Dr. Gregor Bauer credits his trading success to combining fundamental aspects of a trade with expert technical analysis. A Certified Financial Technician from the International Federation of Technical Analysts (IFTA), he’s rated as one of Germany’s top 300 economic experts.

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