Morningstar analysts have suggested that recent fears surrounding the software industry are exaggerated, presenting a prime opportunity for investors to purchase shares at lower prices. The analysts specifically pointed to Microsoft and ServiceNow as two stocks that have seen significant declines but possess “substantial upside potential.”
The sentiment among investors took a downturn last week as speculation grew that Anthropic’s AI assistant, Claude, could disrupt not only the software industry but also the entire framework of IT departments. Following this, the iShares Expanded Tech-Software Sector ETF (IGV) plunged 19% between January 26 and February 5. The Nasdaq index also felt the strain, declining for three consecutive days, contributing to an overall bearish outlook on U.S. software stocks.
Despite these trends, Morningstar Inc., a prominent investment research firm, has indicated that such concerns are largely unfounded. Dan Romanoff, a senior equity analyst at Morningstar, stated, “We see little evidence that the bearish logic is materializing – customer retention rates and other core software metrics remain robust. In short, while we acknowledge the risks, we believe market concerns are excessive.”
Romanoff further argued that the notion of corporate software clients pivoting towards in-house solutions is overstated. He acknowledged potential pressure on user account purchases but emphasized a lack of evidence indicating this shift is occurring. He pointed out that automation has been an enduring trend, not a sudden disruption.
On February 5, U.S. software stocks experienced a notable rebound, with the IGV increasing by over 3% and the Nasdaq index rising more than 2%. Romanoff highlighted that, despite the intensity of the sell-off, investment opportunities still exist across the software sector, particularly for companies like Microsoft and ServiceNow, which he considers to have significant room for growth. Year-to-date, Microsoft and ServiceNow’s stock prices have fallen by 17% and 35%, respectively.
Romanoff provided a “fair value estimate” of $600 for Microsoft’s stock, suggesting a potential increase of 50%. For ServiceNow, he estimated a fair value of $200, which implies a potential price increase of up to 100%. However, he did caution that the current market climate in the software sector is not conducive for those with a low risk tolerance.
Amid ongoing fears that AI technologies like Claude will fundamentally alter the software landscape, Romanoff believes investors have misjudged the actual implications of this trend. Many companies have expressed a cautious approach to AI integration, underscoring the uncertainty that still surrounds these technologies.
“Despite the ongoing hype, AI products have not generated significant revenue for software providers, as management teams are generally concerned about issues such as AI hallucinations and uncontrollable agents,” Romanoff noted. He observed that revenue from AI solutions typically accounts for only about 2% of total revenue for publicly listed software companies. This pattern is reflected in the revenue structure of OpenAI, which relies heavily on consumer subscriptions.
As the market continues to process the implications of emerging technologies, the software sector remains a focal point for investors. The contrasting views on the industry’s future indicate a broader debate about the long-term viability of traditional software solutions in the face of rapid technological advancement.
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