Morgan Stanley thinks the time has come to get more aggressive on software stocks.
Last week, the investment firm held a virtual tech conference, and analyst Keith Weiss found that the tone from most software company executives was bullish — in contrast to the recent selloff in the group. And he thinks that the result is that software as a group looks more attractive. Weiss lifted his industry view on software to Attractive from In Line.
Weiss says that the overall software group is down 16% from recent highs, with companies growing more than 20% off 21% on average. The pullback is tied to rising interest rate fears, he notes, rather than any worries on underlying fundamentals.
Weiss says that his research finds that an increase in rates of 1 percentage point tends to cut software sales multiples by 21%, while a drop of 1.5 points trims multiples by 28%, and a 2 percentage point increase reduces multiples by 35%.
Weiss points out that in the current move, rates on the 10-year Treasury have increased about 100 basis points from last year’s bottom — a move that he says now looks priced into software stock valuations. The analyst says that his firm’s economics team sees the 10-year yield inching up to 170 basis points by year-end, suggesting “marginal additional downside.” But he also says that the selloff has improved the risk/reward ratio across much of the software group.
“Increasing stability in interest rates going forward, shifting market dynamics from the recovery trade toward the expansion phase, and continued strong results in an improving spending environment all represent potential positive catalysts for the group,” he wrote.
Weiss breaks down the software group into categories.
- He suggests aggressively buying growth-at-a-reasonable-price names, including Intuit (ticker: INTU), Microsoft (MSFT), and Palo Alto Networks (PANW).
- He’s also bullish on companies with “durable growth franchises,” pointing to Adobe (ADBE), Domo (DOMO), Nuance Communications (NUAN), NICE (NICE), ServiceNow (NOW), Splunk (SPLK), Workday (WDAY), Veeva Systems (VEEV), and ZoomInfo Technologies (ZI).
- Weiss also suggests buying companies with strong growth stories. “Even if the multiples appear high versus historical levels, the improving spending environment should prove current consensus revenue forecasts conservative,” he wrote. His picks here include Anaplan (PLAN), Atlassian (TEAM), Chegg (CHGG), Coupa Software (COUP), DocuSign (DOCU), MongoDB (MDB), RingCentral (RNG), and Twilio (TWLO)
He has Overweight ratings on all of the stocks mentioned above.
Write to Eric J. Savitz at [email protected]
