After experiencing a remarkable surge in 2023, software stocks are now facing a new reality. Last year, the sector soared by an impressive 58%, fueled by the excitement around generative artificial intelligence, cost-cutting measures, and the anticipation of lower interest rates. However, as we enter 2024, it’s time for investors to adopt a more discerning approach.
While some of the significant trends that drove last year’s performance are still intact, there are new factors to consider. The AI revolution is just getting started, and companies across industries are continuously seeking ways to enhance profitability and efficiency. However, the sector’s outlook for this year is slightly more mixed due to uncertain demand conditions and the timing of AI’s impact on profits.
According to BNP Paribas analyst Stefan Slowinski, software stocks are currently no more expensive than they were a year ago. In his recent comprehensive report on the industry’s prospects, Slowinski highlights that the sector has benefited from the “year of efficiency” and the emergence of new growth opportunities driven by GenAI. However, he also cautions that demand trends have yet to show signs of improvement.
Considering this dynamic landscape, Slowinski has adjusted his stance on software stocks. He now adopts a slightly more defensive position due to persistently weak demand trends and the potential risk of disappointment in GenAI monetization in the short term. Additionally, if the Federal Reserve fails to lower interest rates as quickly as the market expects, software stocks could face unexpected challenges.
In light of these developments, Slowinski recently revised his ratings on three prominent software companies. Adobe, Shopify, and Zoom Video Communications have now been downgraded from Neutral to Underperform. Slowinski emphasizes that Adobe and Shopify are already trading at over 12 times forward sales multiples.
As the software sector enters a new phase of growth in 2024, investors should approach it with careful consideration. While the potential for continued success exists, the mixed performance outlook and evolving market dynamics call for a more cautious and discerning investment strategy.
Key Takeaways
- Software stocks witnessed significant growth in 2023, primarily driven by generative artificial intelligence, cost-cutting measures, and the expectation of lower interest rates.
- The AI trend is still in its early stages, and companies are actively seeking ways to improve profitability through enhanced efficiency.
- However, demand conditions remain uneven, and the timing of AI’s impact on profitability introduces uncertainty into the sector’s performance for 2024.
- BNP Paribas analyst Stefan Slowinski has adjusted his stance on software stocks, adopting a more defensive position due to weak demand trends and the risk of short-term GenAI monetization disappointment.
- Should the Federal Reserve fail to lower interest rates promptly, software stocks could face unforeseen challenges.
- Adobe, Shopify, and Zoom Video Communications have been downgraded to Underperform from Neutral, with Adobe and Shopify already trading at over 12 times forward sales multiples.
Rate-Cut Disappointments and GenAI Competition Pose Risks
According to renowned analyst Slowinski, there are certain risks associated with rate-cut disappointments and increasing GenAI competition that need to be considered. This observation applies specifically to Shopify and Adobe. Slowinski underscores the impact of consumer discretionary spend exposure on Shopify’s performance and highlights the heightened competition for Adobe in the field of GenAI.
Zoom’s Growth Acceleration Comes Under Scrutiny
In a recent analysis, channel checks have raised concerns about Zoom’s ability to deliver on the expected enterprise growth acceleration by 2024. These doubts cast a shadow of uncertainty over Zoom’s future prospects.
Microsoft’s Positive Outlook: Solid Defensive Qualities and Restructuring Benefits
On a positive note, Slowinski remains optimistic about Microsoft’s position in the industry and upgrades their stock rating to Outperform from Neutral. He highlights Microsoft’s defensive qualities, including one of the lowest valuations in the group based on price-to-earnings ratio. Additionally, he anticipates significant benefits from the integration of Activision and the potential for an earnings beat this year, driven by the Azure cloud business. Furthermore, Slowinski predicts that free cash flow improvements in fiscal year 2025 will shift Microsoft’s focus from GenAI investment to GenAI returns.
Promising Future for Oracle, Salesforce, and SAP
Slowinski maintains his positive outlook on Oracle, Salesforce, and SAP, predicting a potential 20% earnings-per-share growth for all three companies. These projections indicate a bright future for these industry giants.
Workday and Alphabet Maintain Positive Momentum
Both Workday and Alphabet continue to receive a bullish rating from Slowinski. Their strong market performance and growth potential make them attractive options for investors.
Neutral Ratings for Amazon.com, Intuit, ServiceNow, and Snowflake
In addition to the positive ratings, Slowinski maintains a Neutral rating for Amazon.com, Intuit, ServiceNow, and Snowflake. While these companies still maintain their strength in the industry, Slowinski does not see significant growth potential for them at the moment.
Market Performance
In terms of market performance, Microsoft shares have seen a 0.6% increase on Thursday. Conversely, Shopify is down 0.7%, Adobe is 1.3% lower, and Zoom has experienced a 1.5% decline.
