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3 Software & Services Stocks with Improving Prospects in 2023
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The outlook for the Internet-Software & Services industry appears mixed. Estimates have been increasing since January, driven by companies seeing strong resurgence in their businesses. Others were positively impacted by the pandemic and the rush-to-digitize trend to which it gave rise, but then fell into a tough spot as the market corrected itself. The possibility of a recession is also leading to cautiousness at some players even as others remain optimistic about their prospects, despite the macro concerns. The diversity of players in this group leads to some dissonance.
Being the backbone of the digital economy, it’s hard to see this industry doing badly over the long term. Some of the long-term trends are playing out this year even as concerns of a slowing economy loom large. Improving economic indicators and continued geopolitical tensions affect most players, but some are better equipped than others to deal with the situation.
The industry usually trades at a premium to the S&P 500 because of its innovation-driven growth, but with prices coming down in recent months, now may be a good time to buy some stocks. Our picks are NetEase (NTES - Free Report) , Sabre Corp. (SABR - Free Report) and Okta (OKTA - Free Report) .
About the Industry
The Internet Software & Services industry is a relatively small industry, primarily involved in enabling platforms, networks, solutions and services for online businesses, and facilitating customer interaction and use of Internet-based services.
Top Themes Driving the Industry
The level of technology adoption by businesses impacts growth. While some companies have already built their platforms, facilitating the development and use of artificial intelligence, others are scrambling to catch up in order to stay competitive. This is further accelerating the adoption of technology that can help collect and analyze data, whether on premise or in the cloud. Additionally, today we have many more "cloud-first" companies than ever before. Therefore, there is steadily increasing demand for software and services delivered through the Internet.
The last few years have been tumultuous for the industry, but the most recent inflation numbers have raised hopes that the Fed’s inflation-fighting measures will not land us into a recession. Unfortunately, the geopolitical tensions in Europe have a bearing on oil prices and supply chains, and therefore, contribute to a certain amount of volatility within the economy. Since the industry thrives on a strong economy that continues to do increasing levels of business, the outlook for 2023 is still cloudy.
The current instability in demand is increasing uncertainties for players. Since software and services are of varying kinds, some players did well during the pandemic while others did well during the reopening. Players increasingly prefer a subscription-based model, which brings relative stability, especially when the companies have critical offerings. The ability to retain subscribers and raise prices as necessary is proving to be the key to success in the current environment.
The higher volume of business being operated through the cloud and the increasing demand for enabling software and services involves infrastructure buildout, which increases costs for players. This causes great fluctuations in profitability as new infrastructure is depreciated and fresh debt is serviced. So even for those players that see revenue growth accelerate, profitability is often a challenge.
Zacks Industry Rank Indicates Improving Prospects
The Zacks Internet – Software & Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #98, which places it in the top 39% of more than 250 Zacks classified industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates that the industry is coping better than many others. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the top 50% of Zacks-ranked industries is because the earnings outlook for the constituent companies in aggregate is improving. The aggregate estimate revisions indicate that analyst opinion likely bottomed in January, with estimates for both 2023 and 2024 trending up since then. The group’s aggregate earnings for 2023 are now up 27.8% over the past year while the 2024 estimate is up 15.4%.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
The Zacks Internet – Software & Services Industry has lagged both the broader Zacks Computer and Technology Sector and the S&P 500 over the past year, although there was a spike in January.
The aggregate share price of the industry increased 10.8% over the past year compared to the broader sector’s increase of 27.8% and the S&P 500’s increase of 17.8%.
One-Year Price Performance
Image Source: Zacks Investment Research
Industry's Current Valuation Is Rich
While many of the individual players are still making losses, the industry as a whole continues to generate profits. Therefore, on the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at a 27.0X multiple, which is a 15.9% discount to its median level of 32.1X over the past year. The S&P 500’s P/E is, however, just 19.92X (median value over the past year is 18.2X). The industry is also overvalued compared to the sector’s forward-12-month P/E of 25.7X. The premium to the industry at the median level is 45.7%.
The industry has traded in the annual range of 27.0X to 44.6X, as the chart below shows.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
3 Stocks Worth Considering
NetEase, Inc. (NTES - Free Report) : Hangzhou-based NetEase provides online services focusing on diverse content, including games, music, other services and education (dictionary, translation and including a range of smart devices) in China. Its products and services are focused on community, communication and commerce.
NetEase is currently building its international business through fresh gaming content that appeals to an international audience. For this purpose, it has also established its own studios in Japan, Europe and North America, and is building creative talent in these regions. It is also expanding reach beyond PCs and mobile devices to consoles that facilitate gameplay seamlessly across devices, which further helps to grow the user base.
In the last quarter, the company saw particular strength in gaming, on the back of new releases. With several other new games spanning different genres and geographies in the pipeline, management is optimistic about customer additions and growth prospects.
The company focuses on dynamic, premium content across its family of apps because that is what attracts people and keeps them attached. The music business has benefited from this focus, growing into a strong contributor. Its search engine Youdao is also doing extremely well, driven by the fresh content it provides.
Shares of this Zacks Rank #1 (Strong Buy) company have gained 20.0% over the past year. The Zacks Consensus Estimate for the 2023 has increased 34 cents (6.2%) in the last 60 days. The 2024 earnings estimate has increased 69 cents (11.7%).
Price and Consensus: NTES
Image Source: Zacks Investment Research
Sabre Corporation (SABR - Free Report) : Southlake, Texas-based Sabre Corp. offers a global distribution system connecting travel suppliers, such as airlines, hotels, car rental companies and cruise lines with travel buyers. It offers hospitality, professional services, software licensing and maintenance, and advertising solutions targeting reservations, operations and marketing. Fees are charged either upfront or on a subscription basis.
Sabre is seeing continued strength in the travel market with bookings improving every quarter. The company has strategic plans to reposition the business to target new revenue growth opportunities. However, the realignment and reduction of its cost structure, essential for this purpose, will lead to employee severance across its global operations.
Shares of this Zacks Rank #1 company have dropped 37.8% over the past year. The expected loss per share for 2023 has been cut by a couple of cents in the last 60 days. Meanwhile, the expected earnings for 2024 have gone from 18 cents a share to 23 cents.
Price and Consensus: SABR
Image Source: Zacks Investment Research
Okta, Inc. (OKTA - Free Report) : Okta provides a wide range of identity and access and authentication solutions for small and medium-sized businesses, universities, non-profits and government agencies within the U.S. and abroad. Its products are sold through a direct sales force and channel partners. It is headquartered in San Francisco, CA.
The company is on track to grow its business at a 37% CAGR between 2021 and 2024. Management estimates that the total addressable market for Okta is $80 billion and its innovative product portfolio of Privileged Access, Identity Governance and Access Management solutions (both workforce and customer) that are provided as a single platform positions it for rapid expansion.
While macro pressures are building up, secure access is vital to operations and the scope for growth substantial, which is likely what drove the increase in backlog and the improvement in revenue and profit outlook for the year. Okta generates 97% of revenue from subscriptions and has a 95% customer retention rate, which provides excellent visibility.
Shares of this Zacks Rank #2 company are down 25.9% over the past year. Its 2024 (ending January) estimate is up 15 cents (19.7%) in the last 60 days. The 2025 estimate is up 13 cents (11.2%) during the same time period.
Price and Consensus: OKTA
Image Source: Zacks Investment Research
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3 Software & Services Stocks with Improving Prospects in 2023
The outlook for the Internet-Software & Services industry appears mixed. Estimates have been increasing since January, driven by companies seeing strong resurgence in their businesses. Others were positively impacted by the pandemic and the rush-to-digitize trend to which it gave rise, but then fell into a tough spot as the market corrected itself. The possibility of a recession is also leading to cautiousness at some players even as others remain optimistic about their prospects, despite the macro concerns. The diversity of players in this group leads to some dissonance.
Being the backbone of the digital economy, it’s hard to see this industry doing badly over the long term. Some of the long-term trends are playing out this year even as concerns of a slowing economy loom large. Improving economic indicators and continued geopolitical tensions affect most players, but some are better equipped than others to deal with the situation.
The industry usually trades at a premium to the S&P 500 because of its innovation-driven growth, but with prices coming down in recent months, now may be a good time to buy some stocks. Our picks are NetEase (NTES - Free Report) , Sabre Corp. (SABR - Free Report) and Okta (OKTA - Free Report) .
About the Industry
The Internet Software & Services industry is a relatively small industry, primarily involved in enabling platforms, networks, solutions and services for online businesses, and facilitating customer interaction and use of Internet-based services.
Top Themes Driving the Industry
Zacks Industry Rank Indicates Improving Prospects
The Zacks Internet – Software & Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #98, which places it in the top 39% of more than 250 Zacks classified industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates that the industry is coping better than many others. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the top 50% of Zacks-ranked industries is because the earnings outlook for the constituent companies in aggregate is improving. The aggregate estimate revisions indicate that analyst opinion likely bottomed in January, with estimates for both 2023 and 2024 trending up since then. The group’s aggregate earnings for 2023 are now up 27.8% over the past year while the 2024 estimate is up 15.4%.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry's Stock Market Performance Remains Relatively Weak
The Zacks Internet – Software & Services Industry has lagged both the broader Zacks Computer and Technology Sector and the S&P 500 over the past year, although there was a spike in January.
The aggregate share price of the industry increased 10.8% over the past year compared to the broader sector’s increase of 27.8% and the S&P 500’s increase of 17.8%.
One-Year Price Performance
Image Source: Zacks Investment Research
Industry's Current Valuation Is Rich
While many of the individual players are still making losses, the industry as a whole continues to generate profits. Therefore, on the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at a 27.0X multiple, which is a 15.9% discount to its median level of 32.1X over the past year. The S&P 500’s P/E is, however, just 19.92X (median value over the past year is 18.2X). The industry is also overvalued compared to the sector’s forward-12-month P/E of 25.7X. The premium to the industry at the median level is 45.7%.
The industry has traded in the annual range of 27.0X to 44.6X, as the chart below shows.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
3 Stocks Worth Considering
NetEase, Inc. (NTES - Free Report) : Hangzhou-based NetEase provides online services focusing on diverse content, including games, music, other services and education (dictionary, translation and including a range of smart devices) in China. Its products and services are focused on community, communication and commerce.
NetEase is currently building its international business through fresh gaming content that appeals to an international audience. For this purpose, it has also established its own studios in Japan, Europe and North America, and is building creative talent in these regions. It is also expanding reach beyond PCs and mobile devices to consoles that facilitate gameplay seamlessly across devices, which further helps to grow the user base.
In the last quarter, the company saw particular strength in gaming, on the back of new releases. With several other new games spanning different genres and geographies in the pipeline, management is optimistic about customer additions and growth prospects.
The company focuses on dynamic, premium content across its family of apps because that is what attracts people and keeps them attached. The music business has benefited from this focus, growing into a strong contributor. Its search engine Youdao is also doing extremely well, driven by the fresh content it provides.
Shares of this Zacks Rank #1 (Strong Buy) company have gained 20.0% over the past year. The Zacks Consensus Estimate for the 2023 has increased 34 cents (6.2%) in the last 60 days. The 2024 earnings estimate has increased 69 cents (11.7%).
Price and Consensus: NTES
Image Source: Zacks Investment Research
Sabre Corporation (SABR - Free Report) : Southlake, Texas-based Sabre Corp. offers a global distribution system connecting travel suppliers, such as airlines, hotels, car rental companies and cruise lines with travel buyers. It offers hospitality, professional services, software licensing and maintenance, and advertising solutions targeting reservations, operations and marketing. Fees are charged either upfront or on a subscription basis.
Sabre is seeing continued strength in the travel market with bookings improving every quarter. The company has strategic plans to reposition the business to target new revenue growth opportunities. However, the realignment and reduction of its cost structure, essential for this purpose, will lead to employee severance across its global operations.
Shares of this Zacks Rank #1 company have dropped 37.8% over the past year. The expected loss per share for 2023 has been cut by a couple of cents in the last 60 days. Meanwhile, the expected earnings for 2024 have gone from 18 cents a share to 23 cents.
Price and Consensus: SABR
Image Source: Zacks Investment Research
Okta, Inc. (OKTA - Free Report) : Okta provides a wide range of identity and access and authentication solutions for small and medium-sized businesses, universities, non-profits and government agencies within the U.S. and abroad. Its products are sold through a direct sales force and channel partners. It is headquartered in San Francisco, CA.
The company is on track to grow its business at a 37% CAGR between 2021 and 2024. Management estimates that the total addressable market for Okta is $80 billion and its innovative product portfolio of Privileged Access, Identity Governance and Access Management solutions (both workforce and customer) that are provided as a single platform positions it for rapid expansion.
While macro pressures are building up, secure access is vital to operations and the scope for growth substantial, which is likely what drove the increase in backlog and the improvement in revenue and profit outlook for the year. Okta generates 97% of revenue from subscriptions and has a 95% customer retention rate, which provides excellent visibility.
Shares of this Zacks Rank #2 company are down 25.9% over the past year. Its 2024 (ending January) estimate is up 15 cents (19.7%) in the last 60 days. The 2025 estimate is up 13 cents (11.2%) during the same time period.
Price and Consensus: OKTA
Image Source: Zacks Investment Research