Software Stocks: Time to Buy or Sell?
Some commentators believe this is the beginning of the end for software. Just yesterday A Goldman Sachs analyst compared the recent decline of the software sector to the beginning of the newspaper industry’s decline in the early 2000s. They believe that software stocks are declining because the terminal value of these companies will decline rapidly.
Undoubtedly, the sell-off devalues the ultimate value of almost all software, as many believe AI will consume the SaaS industry.
Still, other investors believe this could be a great buying opportunity. Even Jensen Huang, the CEO of Nvidiaadmitted that it is absurd to believe that people and companies will stop using software. The existing software solutions could be the most likely place where AI solutions can be best used by companies and their customers.
Unfortunately, no one can predict the future. The market shoots first and asks questions later. In general, it swings too far in one direction before moderating into a healthier, more balanced view.
For investors, the smartest thing you can do is make sure you have a diversified portfolio. Many people have been caught out by this downturn. Software-as-a-Service business models are so profitable that they require substantial valuation multiples. Over the past decade, they have become significantly overweight positions in many investor portfolios.
If you believe in software, this could be a great buying opportunity
If you believe the latter view (that software will still serve a purpose for years to come), this could be an attractive time to build new positions in some of the top quality names. Many trade at attractive valuations with high cash flow yields.
Many institutional investors have simply left the software world. Until these software companies can prove that: 1. AI won’t hinder their operations, or 2. improves their operations (even better), there will likely be an overhang on these stocks.
This will probably take the rest of the year to feel this way. As a result, these stocks may sulk for a while. You will have to be extremely patient and accustomed to discomfort when buying the sector.
Descartes Systems
One software file at the top of my radar is Descartes Systems Group (TSX:DSG). This has always been an expensive stock. Although the stock is down 46% in the past year, it is still trading at a premium. Yet it is trading at its cheapest valuation since 2017.
What many investors don’t realize is that Descartes is first and foremost a network. It operates a global logistics network that connects supply chain participants around the world. Once a customer is connected to the network, it is very difficult to change.
Likewise, Descartes is beginning to use AI to unlock its significant amounts of data. The global trading environment is becoming increasingly challenging. If it can use AI to improve shipping insights, it could see even more customers coming its way.
Descartes has a cash-rich balance sheet. With valuations falling significantly, Descartes will likely be very opportunistic in consolidating other software vendors. This could be an example of the rich getting richer and the poor getting poorer. Choose the best quality software stocks (like Descartes) during the downturn and they can still deliver good returns in the coming years.
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