Enterprise Software Stocks: Many Tiptoed Out Of The Doghouse In Early 2023

Some enterprise software stocks tiptoed out of the doghouse in early 2023, yet they still haven't won the favor that other tech players enjoy.

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After tumbling more than a third in 2022, the iShares Expanded Tech-Software ETF (IGV) — comprised of many of the major enterprise software players — has advanced 9.7% for 2023 as of Thursday's close.

That outpaces the S&P 500, but the fund's early gains still lag the tech-heavy Nasdaq composite. The Nasdaq has forged ahead 10.8% while the S&P 500 is up 6.2%.

Some of these enterprise players that make software for large businesses have clawed back in early 2023. Last year, these companies were roasted as the iShares ETF plunged 35.7%. Now that valuations have dropped, the stocks may have caught the eye of private equity firms, among others.

"With software valuations back at digestible levels, the focus is now on estimates to create a trustworthy base for investors," Barclays analyst Raimo Lenschow said in a recent note to clients. "This process has started, but we are not sure we are fully there yet."

Enterprise Software: Double-Digit Gains

Enterprise software stocks with double-digit gains in 2023 include Salesforce (CRM), Atlassian (TEAM), ServiceNow (NOW), Palantir (PLTR) and Twilio (TWLO). Also on the list are GitLab (GTLB), Smartsheet (SMAR), Five9 (FIVN) and Sumo Logic (SUMO). HubSpot (HUBS), which serves primarily small-to-midsize businesses, also is surging.

JFrog (FROG), which sells programming tools that automate software development, also has been on a roll. JFrog is the IPO Stock Of The Week.

Further, enterprise software stocks with the highest percentage of subscription-based, recurring revenue numbers stand out. They're known as software-as-a-service, or SaaS, stocks. Customers of SaaS companies purchase renewable subscriptions, rather than one-time software licenses. SaaS companies include Salesforce, HubSpot and Twilio, among others.

A few software firms, including Salesforce, have announced job cuts to protect margins. Meanwhile, Salesforce has been targeted by activist investors. Investors also could target Twilio, some analysts say.

Further, Sumo Logic reportedly is being eyed by private equity firms. PE firms in 2022 acquired Zendesk and Coupa Software (COUP).

But the outlook for these stocks is largely tied to what happens with inflation, Federal Reserve rate hikes and 2023 earnings guidance. Further, IBD's enterprise software group ranks only No. 115 out of 197 industry groups tracked.

Volatile Year For Enterprise Software?

At Deutsche Bank, analyst Brad Zelnick said in a note: "We expect 2023 to be another volatile year for software stocks with investors seeking confirmation of a bottom as fundamentals likely deteriorate further."

Microsoft (MSFT) reported mixed results for the December quarter. Microsoft's weak outlook and commentary on a slowing economy pressured some enterprise software stocks with exposure to cloud computing. Those companies include Snowflake (SNOW), Datadog (DDOG) and Confluent (CFLT), and they use cloud firms as a sales channel.

ServiceNow on Jan. 25 reported fourth-quarter earnings that topped views while 2023 subscription revenue guidance came in above expectations. But investors didn't know what to make of it, as shares wavered between gains and losses the next day.

The enterprise software maker is in "a unique position to succeed in a tough IT spending environment," RBC Capital analyst Matthew Hedberg said in a client note.

The company's software tracks and manages services provided by information-technology departments. Also, its self-service tech portal enables company employees to access administrative and workflow tools.

Atlassian Reports Earnings Feb. 2

As Atlassian preps to reports earnings on Feb. 2, TEAM stock has climbed 18% in 2023.

Atlassian sells project management and collaborative enterprise software for software developers and information technology engineering teams. Atlassian has been shifting to cloud computing-based services.

Some analysts favor software stocks, such as ServiceNow, that generate more free cash flow. In addition, some analysts have steered away from companies with high exposure to stock-based compensation.

Software companies remain one of the sectors that offer the best revenue growth in technology. Increased corporate spending on cloud computing, digital transformation, big data analytics and artificial intelligence all drive revenue growth for software stocks.

Software Stocks And Tech Spending

Market research firm Gartner in January cut its 2023 global information technology spending estimate by more than half. Gartner now expects information technology spending to increase just 2.4% in 2023 vs. a 0.2% downturn last year to $4.38 trillion.

Cowen analyst Derrick Wood recently surveyed tech departments on enterprise software spending priorities.

"Our survey projects 7.3% budget growth in 2023, a modest deceleration from 8.3% in 2022," Wood said in a note.

At Goldman Sachs, analyst Kash Rangan expects the enterprise software sector to bounce back in 2023.

"We believe 2023 could constitute a trough for revenue growth that should be corroborated by more tempered management guidance," he said in a note.

Follow Reinhardt Krause on Twitter @reinhardtk_tech for updates on 5G wireless, artificial intelligence, cybersecurity and cloud computing.

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