The Zacks Internet Software industry is suffering from heightened geopolitical risks due to the Russia-Ukraine conflict, higher wage inflation, currency fluctuations and pandemic-related supply chain disruptions. However, industry participants like Paylocity Holding PCTY, PayPal PYPL and Model N MODN benefits from the accelerated demand for digital transformation and the ongoing shift to the cloud. The high demand for SaaS-based solutions due to the increasing need for remote working, learning and diagnostics software as well as cybersecurity applications has been a key driver. Notable is the growing demand for solutions that support hybrid operating environments. Robust IT spending on software is a positive factor for industry participants.
The Zacks internet software industry includes companies that provide application performance monitoring, infrastructure and application software, DevOps deployment, and security software. Industry participants offer multi-cloud application security and delivery, social networking, online payments, and 3D printing applications and solutions. Industry participants use the SaaS-based cloud computing model to provide solutions for both end users and businesses. Therefore, subscriptions are the main source of income. Advertising is also an important source of income. Industry participants target a variety of end markets, including banking and financial services, service providers, federal governments, and animal health technologies and services.
3 trends shaping the future of the internet software industry
Growing adoption of SaaS: The industry benefits from the ongoing demand for digital transformation. The growth prospects are enticing, largely due to the rapid adoption of SaaS, which offers a flexible and cost-effective application delivery method. It also reduces deployment time compared to legacy systems. SaaS seeks to deliver applications to any user, anywhere, anytime, and on any device. It has proven effective in meeting customer expectations of seamless communication across multiple channels including voice, chat, email, web, social media and mobile. This drives customer satisfaction and increases retention rate, driving the top line of industry participants. Additionally, the SaaS delivery model has helped industry participants deploy software applications amid coronavirus-induced lockdowns and on-premises protections. Remote working, learning, and diagnostics have also fueled demand for SaaS-based software applications.
Pay-as-you-go model is gaining traction: The increasingly customer-centric approach allows end users to perform any required actions with minimal intervention from the software vendor. In addition, the pay-as-you-go model helps Internet software providers to scale their offerings according to the needs of different users. Additionally, the subscription-based business model ensures recurring revenue for industry participants. The affordability of the SaaS delivery model, especially for small and medium-sized businesses, is also an important factor. The cloud-based applications are easy to use. Therefore, the need for specialized training is significantly reduced, which reduces costs and thereby increases profits.
Ongoing transition to the cloud creates opportunity: Additionally, amid the increasing frequency of cyber attacks and hacking, the growing need for secure cloud platforms is driving the demand for web-based cyber security software. As organizations continue to move their on-premises workloads to cloud environments, application and infrastructure monitoring becomes more important. This increases the demand for web-based performance management monitoring tools.
Zacks’ industry ranking suggests a bleak outlook
The Zacks internet software industry within the broader Zacks computer and technology sector carries a Zacks industry rank of #138, which places it in the bottom 45% of more than 250 Zacks industries.
The Group’s Zacks Industry Rank, which is the average of the Zacks Rank of all member stocks, indicates near-term prospects. Our research shows that the top 50% of industries evaluated by Zacks outperform the bottom 50% by a factor of more than 2 to 1.
Despite the bleak outlook for the industry, some stocks have the potential to outperform the market. But before we unveil the top industry picks, it pays to first look at shareholder returns and the industry’s current valuation.
The industry lags behind the sector and the S&P 500
The Zacks internet software industry has underperformed the broader Zacks computer and technology sector and the S&P 500 index over the past year.
The industry is down 59.7% over the period, versus the 6.9% decline in the S&P 500 Index and the 22.5% decline in the broader sector.
One-year price development
Current rating of the industry
Based on the trailing 12-month Price to Sales (P/S) ratio, which is a commonly used multiple to value internet software stocks, we see that the industry is currently trading at 2.22X compared to the 3.93X the S&P 500 trailing 12-month P/S of the sector of 3.82X.
Over the past three years, the industry has traded up to 5.25x, up to 1.78x, and a median of 2.79x, as shown in the chart below.
Trailing 12-Month Price to Sales (P/S) Ratio.
3 Stocks You Can Buy Right Now
Paylocity Holding – This Illinois-based Zacks Rank #2 (Buy) company provides cloud-based payroll and human capital management software solutions to medium-sized businesses in the United States. You can see the full list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Paylocity is benefiting from the increasing acceptance of its solutions by customers with fewer than 50 employees. Healthy momentum at the core of the business and at the top end of the market is tailwind. The release of the Learning Management System and Community Portal, which has received positive feedback from customers, is encouraging. The addition of on-demand payments to the portfolio should also increase customer gains in the long term.
Paylocity’s stock is up 5.2% year-to-date. Zacks consensus estimate for fiscal 2023 earnings is $3.58 per share, up 14.7% over the past 30 days.
Price and Consensus: PCTY
PayPal – This #2 (Buy) Zacks company is benefiting from strong growth in total payment volume due to rising new net active accounts. Strengthening customer loyalty is positive. Venmo’s strong performance also contributes well to overall payment volume growth.
Solid momentum in peer-to-peer and PayPal checkout experiences is Tailwind. Additionally, PayPal’s growing traction in the United States remains a big plus.
PYPL shares are down 50.4% year to date. Zacks consensus estimate for 2022 earnings is up 1% over the past 30 days to $3.92 per share.
Price and Consensus: PYPL
Model N – A solid go-to-market strategy, new logos and robust point-of-sale execution are driving Model N sales growth. The company continues to see strong contributions from subscription booking across its portfolio. It also successfully recorded strong subscription sales.
Shares of this No. 2 Zacks company have returned 1.6% year to date. The Zacks Consensus estimate for Model N’s fiscal 2022 earnings is 70 cents per share, up 22.8% over the past 30 days.
Price and consensus: MODN
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