Despite the macroeconomic challenges, the software industry is well-positioned for growth due to continued digital transformation and the rise of cloud-based solutions. Given this backdrop, it could be wise to buy fundamentally strong software stocks, Microsoft Corporation (MSFT), ServiceNow, Inc. (NOW), and F5, Inc. (FFIV).

Before delving deeper into their fundamentals, let’s discuss why the software industry is well-positioned for growth.

Enterprises across the globe are focusing on improving their digital capabilities across their operations by integrating smart software solutions. Business software enables enterprises to create, promote, sell, market, manage, and scale their businesses.

The demand for software is growing as businesses aim to increase their productivity, reduce costs, and improve customer management. Apart from enterprises, governments are also increasing their IT spending.

Gartner forecasts global software investment to surpass $922.75 billion in 2023, a 13.7% year-over-year increase, with even higher growth expected in 2024, reaching $1.05 trillion, a 14.1% year-over-year increase. The surge is primarily due to increased demand for cloud-based software and digital transformation initiatives across industries.

The U.S. software market is expanding due to increased banking, retail, and healthcare demand. Software usage has increased due to advancements in AI and cloud computing. The software market revenue is expected to reach $338.20 billion in 2023 and grow at a 4.2% CAGR to reach $414.70 billion by 2028.

Investors’ interest in software stocks is evident from the iShares Expanded Tech-Software Sector ETF’s (IGV) 38% returns over the past year.

Considering these conducive trends, let’s analyze the fundamentals of the three Software – Business stock picks, beginning with the third choice.

Stock #3: Microsoft Corporation (MSFT)

MSFT develops and supports software, services, devices and solutions worldwide. The company’s segments include Productivity and Business Processes, Intelligent Cloud segment, and More Personal Computing.

On September 27, 2023, MSFT and Mercy announced a long-term collaboration using generative AI and digital technologies to enhance patient care. Based on Microsoft's Cloud platform, this collaboration seeks to revolutionize healthcare by using AI insights and modern solutions to improve patient care.

Peter Lee, Corporate VP of Research and Incubations at MSFT, highlighted the potential of generative AI to address healthcare challenges, enhance efficiency, and transform care. He commended Mercy's innovative approach and emphasized that this partnership is just the beginning of a journey to empower healthcare professionals and improve patient care.

In terms of the trailing-12-month EBIT margin, MSFT’s 41.77% is 809.4% higher than the 4.59% industry average. Its 34.15% trailing-12-month net income margin is significantly higher than the 2.03% industry average. Likewise, the stock’s 38.82% trailing-12-month Return on Common Equity is significantly higher than the 0.03% industry average.

MSFT’s total revenue for the fiscal fourth quarter that ended June 30, 2023, increased 8.3% year-over-year to $56.19 billion. Its operating income rose 18.1% year-over-year to $24.25 billion. Moreover, the company’s net income and EPS rose 19.9% and 20.6% year-over-year to $20.08 billion and $2.69, respectively.

For the quarter ended September 30, 2023, MSFT’s EPS and revenue are expected to increase 12.7% and 8.8% year-over-year to $2.65 and $54.54 million, respectively. It surpassed the consensus EPS estimates in each of the trailing four quarters. Over the past nine months, the stock has gained 40% to close the last trading session at $330.11.

MSFT’s strong fundamentals are reflected in its POWR Ratings. It has an overall rating of B, equating to a Buy in our proprietary rating system. The POWR Ratings assess stocks by 118 different factors, each with its own weighting.

It has an A grade for Sentiment and a B for Stability and Quality. It is ranked #11 out of 44 stocks in the B-rated Software – Business industry.

In total, we rate MSFT on eight different levels. Beyond what we stated above, we also have given MSFT grades for Growth, Value, and Momentum. Get all the MSFT ratings here.

Stock #2: ServiceNow, Inc. (NOW)

NOW provides enterprise cloud computing solutions that define, structure, consolidate, manage, and automate services for enterprises worldwide. The company operates the Now platform for workflow automation, artificial intelligence, machine learning, robotic process automation, process mining, performance analytics, electronic service catalogs and portals, data benchmarking, encryption, etc.

On October 3, 2023, NOW announced that Teleperformance is joining the AI Lighthouse program to collaborate on developing industry-specific generative AI use cases to increase productivity and customer and employee satisfaction in Customer Service Management and IT Service Management.

NOW’s Chairman and CEO Bill McDermott said, “Generative AI is unveiling a new frontier of human productivity, leading the way to an era of rising prosperity. AI Lighthouse welcomes brilliant minds across all industries to propel generative AI innovation.”

On July 26, 2023, KPMG and NOW announced an expanded partnership to enhance finance, supply chain, and procurement operations. This collaboration integrates AI, low-code capabilities, and industry expertise to streamline procurement, enhance employee experiences, and improve automation. The partnership leverages their decade-long relationship.

NOW’s Chairman and CEO said, “In this new era of our long‑standing partnership with KPMG, we’re injecting a step‑function increase in speed for our customers’ business architecture. Our co‑developed AI‑driven solutions will maximize productivity and profitability across finance, supply chain, and procurement operations.”

In terms of the trailing-12-month EBITDA margin, NOW's 12.42% is 37.5% higher than the 9.04% industry average. Likewise, its 78.50% trailing-12-month gross profit margin is 59.9% higher than the 49.10% industry average. Furthermore, the stock’s 17.76% trailing-12-month net income margin is 776.3% higher than the 2.03% industry average.

For the second quarter ended June 30, 2023, NOW's total revenues rose 22.7% year-over-year to $2.15 billion. Its non-GAAP gross profit rose 22.7% from the year-ago quarter to $1.76 billion. The company’s non-GAAP earnings per share came in at $2.37, representing an increase of 46.3% year-over-year. Additionally, its non-GAAP net income rose 47.7% year-over-year to $486 million.

Analysts expect NOW's EPS and revenues for the quarter ended September 30, 2023, to increase 30.1% and 24.2% year-over-year to $2.55 and $2.27 billion, respectively. It surpassed the Street EPS estimates in each of the trailing four quarters. Over the past year, the stock has gained 54.3% to close the last trading session at $550.68.

It’s no surprise that NOW has an overall rating of B, which translates to a Buy in our proprietary POWR Ratings system.

It has an A grade for Growth and a B for Sentiment and Quality. Within the same industry, it is ranked #8. To see NOW's Value, Momentum, and Stability ratings, click here.

Stock #1: F5, Inc. (FFIV)

FFIV provides multi-cloud application security and delivery solutions in the United States, Europe, the Middle East, Africa, and the Asia Pacific. The company's multi-cloud application security and delivery solutions enable its customers to develop, deploy, operate, secure, and govern applications in any architecture, from on-premises to the public cloud.

On March 21, 2023, FFIV announced multi-cloud networking (MCN) capabilities for extending application and security services across public clouds, hybrid setups, Kubernetes environments, and edge sites. These services offer integrated network and application layer connectivity and security, simplifying operations and enhancing visibility via a single management console for F5 customers.

Michael Rau, SVP and General Manager, F5 Distributed Cloud Platform and Security Services at FFIV, predicts that secure app-to-app connectivity is a critical goal for digital organizations, especially given the complexity of cloud, microservices, and API-based applications. He believes Distributed Cloud Services will significantly enhance agility and security for hybrid and multi-cloud scenarios.

On March 6, 2023, FFIV and Visa teamed up to improve customer security and streamline merchant logins. This collaboration creates a seamless and secure shopping experience. Using AI and behavior analytics, F5 Distributed Cloud Authentication Intelligence identifies returning customers, eliminating the need for typical logins, enhancing personalization, and reducing guest checkout hassles.

In terms of the trailing-12-month Return on Common Equity margin, FFIV’s 13.34% is significantly higher than the 0.03% industry average. Likewise, its 21.60% trailing-12-month levered FCF margin is 186% higher than the 7.55% industry average. Its 11.84% trailing-12-month net income margin is 484% higher than the 2.03% industry average.

FFIV’s total revenue for the fiscal third quarter that ended September 1, 2023, increased 4.2% year-over-year to $702.64 million. Its non-GAAP gross profit increased 3.2% year-over-year to $579 million. The company’s adjusted net income and adjusted EPS increased 25.2% and 24.9% year-over-year to $193.65 million and $3.21, respectively.

Street expects FFIV’s EPS and revenue for the quarter ended September 30, 2023, to increase 22.5% and 0.3% year-over-year to $3.21 and $702.25 million, respectively. It surpassed the Street EPS estimates in each of the trailing four quarters. Over the past six months, the stock has gained 5.7% to close the last trading session at $150.99.

FFIV’s POWR Ratings reflect solid prospects. It has an overall rating of A, which translates to a Strong Buy in our proprietary rating system.

It is ranked first in the Software - Business industry. It has an A grade for Quality and a B for Growth and Value. Click here to see FFIV’s Momentum, Stability, and Sentiment ratings.

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MSFT shares were trading at $332.30 per share on Thursday afternoon, up $2.19 (+0.66%). Year-to-date, MSFT has gained 39.51%, versus a 12.95% rise in the benchmark S&P 500 index during the same period.

Abhishek embarked on his professional journey as a financial journalist due to his keen interest in discerning the fundamental factors that influence the future performance of financial instruments.

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