Yahoo Finance 'Embrace the suck': What investors need to know about the software stock slump
For software stocks, as Olivia Rodrigo would say, it's brutal out here.
The tech-heavy Nasdaq declined nearly 5% in the past month, closing on Thursday at 13,219.83, and software has especially been in the crosshairs. Salesforce (CRM) and Adobe (ADBE) stocks have seen declines of more than 8% over the past month and even the biggest software names such as Microsoft (MSFT) aren't immune.
Evercore ISI analyst Kirk Materne recently published a note, offering some advice to investors.
"Embrace the suck, but only if you can take a 6-9 month view," he wrote on Oct. 4. "While every pullback in software is unique given that the industry is still maturing and every company is at a different point on the maturity curve, the common thread across nearly every [second half of the year] pullback over the last 10 years is that software outperforms the S&P 500 off the bottom."
This pullback in software stocks goes back to macroeconomic uncertainty as the economy adjusts to higher interest rates and a shifting post-pandemic landscape. Software stocks have gone through these sorts of withdrawals in the back half of the year before.
"We believe this pullback is similar to other ... pullbacks in that investors are taking profits in the face of macro uncertainty — sensible — and we won’t have a great read on [information technology] spending budgets for another 30-60 days," Materne wrote.
To be clear, this is far from the worst tech sell-off, and there's still overarching positive data.
The Nasdaq remains up about 27% year to date and its long-term upward trajectory is clear. Over the last five years, the Nasdaq has gone up approximately 76%.
Software companies to watch
To Materne's point, if software stocks leap off the bottom, who's set to win?
Look at the large-cap names, according to Materne, including Microsoft, Adobe, Intuit (INTU), and Palo Alto Networks (PANW). He also identified a select group of growth names as possible winners, calling out Snowflake (SNOW), CrowdStrike (CRWD), and HubSpot (HUBS).
For many of these names, Wall Street agrees there's room to run.
Take Adobe, for example. CFRA analyst Angelo Zino, who has a Buy rating on the stock, suggests that Adobe shares have upside, especially given the company's potential to leverage AI.
"Our Buy recommendation reflects our view of potential AI monetization opportunities, dominant position in select content creation apps with formidable competitive advantages, and cross-selling prospects," Zino wrote on Sept. 30.
Next, consider Intuit, which just held its annual investor day on Sept. 28. AI came up again.
"In our view, the analyst day provided a good incremental update on Intuit’s platform and AI strategy," William Blair's Matthew Pfau wrote on Sept. 29. "We believe the company is positioning itself well to continue to grow the top line in the low- to mid-teens while providing margin expansion."
What would these companies be excited about if it weren't AI? It's hard to know.
But AI or not, this is a movie investors have seen before, and it's a reminder that investing in software isn't for the faint of heart. It's more cyclical than investors might like to think, and it's in transition between a growth industry and a mature sector.
With that history in mind, some say this is an opportunity.
"While we expect that software stocks are at the mercy of the macro backdrop (and interest rates) in the immediate near-term, prior [second half of the year] pullbacks in software have ultimately proven to be great relative buying opportunities when taking a 180 or 365 day view," Materne wrote. "This one feels similar — though bigger is better this time around in terms of large cap continuing to outperform small-cap."
Allie Garfinkle is a Senior Tech Reporter at Yahoo Finance. Follow her on Twitter at @agarfinks and on LinkedIn.
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