Software stocks that have taken a beating in this year’s technology stock selloff are showing resilience in their quarterly earnings results. Atlassian Corp Plc (TEAM) and Cloudflare (NET) reported strong results this week, underlying strength in the sector even as economic momentum slows.
ClearBridge Investments said they are “optimistic about the ability of software stocks to outperform over the intermediate and long term and that valuations are at multi-year lows in some cases.” A Goldman Sachs basket of high-growth software stocks has dropped -41% in 2022, more than double the decline on the Nasdaq 100 Index ($IUXX) (QQQ).
This year, the slump in software stocks came as the Fed began aggressively raising interest rates to fight inflation, a bearish factor for high-valuation stocks that are priced on their long-term prospects. Mizuho Securities said, “by and large, software weakness has been 100% about the macro environment, not fundamentals.” Recent quarterly earnings results illustrate the enduring strength of their businesses.
The Goldman Sachs basket of high-growth software stocks currently trades at 7.8 times forward sales, about half its average going back to 2018. In early 2021, it was trading about 25 times estimated sales. The Nasdaq 100 Index as a whole has a multiple of about four times estimated sales. Of the 38 companies in the S&P 500 software and tech service sector that have reported Q2 earnings, 28 exceeded earnings estimates, while seven have missed.
Bloomberg Intelligence data shows analysts expect earnings for the software and services sector will climb about 12% in 2023, compared with the 15% pace that was expected in late February. Revenue is expected to grow 11%, down from the 12% pace expected in early July. However, UBS Global Wealth Management warns that it is too soon to move back into growth technology stocks, saying, “the rising cost of capital, tightening financial conditions, and growing recession risks are likely to limit the upside for unprofitable tech companies given limited near-term scope for strong margin expansion.”
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