Though technology stocks have hit the skids this year, Goldman Sachs analysts see some opportunities in the software sector.
“While the probability of a recession is low, we believe software business models are far more insulated from severe economic shocks than past downturns,” they wrote in a commentary.
That’s because of “the reliance on recurring revenue and built-in expense agility that can support operating leverage,” they said.
“This combination can make the sector a more defensive play than it was in the past, as we saw at the onset of the pandemic.”
The tech stock selloff has many software companies seemingly trading at a sizable discount to their intrinsic value, the analysts said.
“Our intrinsic value analysis coupled with assessment of long-term growth and margin potential leads us to focus on growth companies with profits … as defensives.”
That includes including Microsoft (MSFT), Salesforce (CRM), ServiceNow (NOW), Adobe (ADBE), Intuit (INTU) and Workday (WDAY).
Which Companies Did Well?
As for Microsoft, it’s “probably one of the most resilient earnings stories in the technology industry and across sectors,” the analysts said.
“The combination of continued operating leverage, as its cloud business reaches about a $90 billion run-rate, and sustainable earnings-per-share growth should drive a potential doubling of earnings per share from fiscal 2022 to fiscal 2027.”
In addition, “Microsoft is an efficient capital allocator, as evidenced by a successful track record of acquisitions, dividends and share purchases,” the analysts said. "[That] argues for a compelling total return story.”
Turning to Salesforce, it should enjoy earnings improvement, despite a weakening macroeconomic environment, the analysts said. That’s what happened in the down cycles of 2008-2009 and 2020.
“Salesforce should be able to simultaneously see higher margins due to the easing of expenses and see sustained revenue growth generated by prior bookings,” the analysts said.
“One of the first categories to benefit from improvement in appetite for strategic enterprise information technology investments is the front office category in which CRM plays.”
Looking at ServiceNow, “the company has a very unique combination of a core IT service management and operations business, which comprise 70% to 75% of revenue,” the analysts said.
“The core can be argued as a defensive product category, especially as IT departments gain increasing influence under potentially tightening wallet conditions.”
The rest of the company’s business, focusing on employee, customer and creator workflows, (custom app development) can be viewed as an offensive share gainer, the analysts said.
“As enterprises shift their data center assets to the public cloud in the long term, we believe the value proposition of ServiceNow to its customers will only increase, given the physical separation of IT assets from the business owners.”
The author of this story owns shares of Microsoft, Salesforce and Adobe.
