The Zacks Business-Software Services industry is benefiting from increased demand for digital transformation and the ongoing transition to the cloud. The increasing automation of business processes in many industries and the rapidly increasing volumes of enterprise data are also driving the demand for enterprise software and services. Industry participants like MSCI (MSCI – free report), Tyler Technologies (TYL – free report), TD SYNNEX (SNX – free report) and guidewire software (GWRE – Free Report) are taking advantage of these trends.
The pandemic-induced health crisis has opened up new avenues of growth for business software vendors over the past two years. Industry players have seen strong demand for software as a service (SaaS) amid the pandemic-triggered growing need for remote working, e-learning and diagnostic software. SaaS offers a flexible and cost-effective method of delivering applications. It also reduces deployment time compared to legacy systems. Moreover, SaaS attempts to deliver applications to any user, anywhere, anytime and on any device.
Description of the industry
Zacks’ commercial software services industry primarily includes companies that provide application-specific software products and services. Apps are usually license-based or cloud-based. Offerings typically include applications related to finance, sales and marketing, human resources, and supply chain, among others. The industry includes 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 suits, integration systems, infrastructure services and network security applications. Some companies offer investment decision support tools. The manufacturing, retail, banking, insurance, telecommunications, healthcare and public sectors are the major end markets for industry players.
4 trends shaping the future of the enterprise software services industry
Opportunities to transition to cloud building: Companies in this industry have benefited from the strong demand for multi-cloud software solutions, given the ongoing 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 result-oriented. Most industry players now offer cloud-based versions of their solutions in addition to on-premises versions, expanding content accessibility. Enhanced interoperability features provide customers with differentiation and efficiency.
The subscription model is gaining ground: Industry players are changing their business models to meet changing customer demands. Revenue pricing models based on subscriptions and term licenses have become very popular and are now replacing the old upfront payment prototype. Subscription-based business models provide increased revenue visibility and higher recurring revenue, which bodes well for long-term businesses. However, due to this transition, the revenue growth of these companies may be affected in the coming days, as term license revenue includes advance payments, while subscription revenue is a bit delayed.
Ongoing mergers and acquisitions to expand product offerings: Players in this industry resort to frequent mergers and acquisitions to provide complementary and end-to-end software products. Nonetheless, increasing investments in digital deals and acquisitions could erode industry profitability in the coming period.
Good IT spending forecasts bode well: Gartner’s latest global IT spending forecast is positive for industry players. Global IT spending is expected to be $4.43 trillion in 2022, suggesting a 4% increase from 2021. Gartner in its research report said ongoing geopolitical disruptions, pressure inflationary and protracted pandemic-induced supply chain issues will not affect the recovery seen in IT spending worldwide. This bodes well for the industry’s performance.
Zacks’ Industry Rankings Indicate Bright Prospects
The Zacks Business-Software Services industry is housed within the broader Zacks Computer and Technology sector. It carries a #95 Zacks Industry ranking, which places it in the top 38% of over 250 Zacks industries.
The group’s Zacks Industry Rank, which is essentially the average Zacks Rank of all member stocks, indicates a bright near-term outlook. Our research shows that the top 50% of industries ranked by Zacks outperform the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the top 50% of industries ranked by Zacks is the result of the positive earnings outlook for the constituent companies overall. Looking at revisions to overall earnings estimates, it appears analysts are optimistic about the earnings growth potential of this group. The industry’s 2022 earnings estimate rose 12.9% to 96 cents over the past year.
Revised estimates for 2022
Before outlining a few stocks you might consider for your portfolio, let’s take a look at recent stock market performance and the industry valuation picture.
Industry lags S&P 500, outperforms sector
The Zacks Business-Software Services industry underperformed the S&P 500 Index, but outperformed the broader Zacks Computer And Technology sector over the past year.
The industry fell 8.1% during the period, compared with the broader sector’s 15.9% decline and the S&P 500’s 3.2% decline.
Year-over-year price performance
Current industry assessment
Comparing the industry with the S&P 500 composite and the broader sector based on the 12-month price-to-earnings ratio, which is a multiple commonly used to value enterprise software services stocks, we find that the industry ratio of 21.19 is higher than the S&P 500’s 17.30 and the sector’s 20.31.
Over the past five years the industry has traded as low as 37.75X, as low as 6.60X and recorded a median of 22.11X as seen in the charts below.
F12M Price to Earnings Ratio (Industry vs S&P 500)
F12M Price to Earnings Ratio (Industry vs Sector)
4 stocks to watch
Tyler Technologies: This Zacks Tier 2 (Buy) company is a leading provider of integrated information management solutions and services for the public sector. The company serves its customers both on-premises and in the cloud.
Tyler is benefiting from higher recurring revenue, post-acquisition contributions from NIC, and a steady rebound in market and sales activity to pre-COVID levels. The public sector’s ongoing transition from on-premises and outdated systems to scalable cloud-based systems is a positive. The coronavirus-induced remote work trend is also driving demand for its connectivity and cloud services.
Shares of this Plano, Texas-based company have fallen 12.5% over the past year. Zacks’ consensus estimate for 2022 earnings rose 9 cents to $7.59 per share in the past 30 days.
Pricing and Consensus: TYL
TD SYNNEX: Founded in 1980, it is a leading business process services company. The company offers a full range of distribution, logistics and integration services for the technology industry and outsourced services focused on customer engagement with a wide range of enterprises.
TD SYNNEX is benefiting from the coronavirus-led work and learning wave, which is driving demand for offsite work and learning hardware and software. Additionally, a stable IT spending environment on the back of rapid digital transformation is a positive. Acquisitions and partnerships help the company expand its product portfolio.
This Fremont, Calif.-based company currently carries the Zacks No. 2 ranking. Zacks’ consensus estimate for fiscal 2022 earnings has risen 42 cents to $11.48 per share over the past 60 days. SNX shares are down 15.5% over the past year.
Pricing and Consensus: SNX
MSCI is benefiting from strong demand for custom and factor index modules, a recurring revenue business model and the growing adoption of its ESG solution in the investment process. MSCI’s expanding portfolio of climate tools should drive revenue. The acquisitions have strengthened its ability to provide climate risk assessment and help investors meet climate risk disclosure requirements. In addition, the strong traction of customer segments such as wealth management, banks and brokers is a positive.
Shares of this New York-based company have fallen 10.2% over the past year. The Zacks consensus estimate for 2022 earnings has moved 16 cents south to $11.38 per share over the past 30 days.
Pricing and Consensus: MSCI
Guidewire software: This San Mateo, California-based company is a provider of software solutions for P&C insurers. The company’s solutions help reduce risk through increased productivity, faster time to market, digital engagement and simplified IT infrastructure.
Guidewire is enjoying higher subscription revenue, as evidenced by its fiscal second quarter results. The company’s subscription offerings benefit from the robust adoption of the InsuranceSuite Cloud platform. Additionally, the focus on enhancing the Guidewire Cloud platform with new features is expected to drive subscription solution sales in the long term. Guidewire’s cloud deployment partner, Amazon Web Services, is also gaining traction. Strategic acquisitions and collaborations, along with a less competitive market and a strong liquidity position, bode well.
This Zacks Rank No. 3 stock has plunged about 15% in the past 12 months. The consensus mark for fiscal 2022 is set at a loss of 53 cents per share, after widening by a penny in 60 days.
Pricing and Consensus: GWRE