Investors holding software stocks must demand growth from them. After all, software companies hold nothing physically tangible. They may have important intellectual property, but their value comes from the solutions and services their programs offer.
Microsoft (NASDAQ:MSFT) or International Business Machines (NYSE:IBM) are easy choices for investors who do not want to spend too much time understanding the software business. Yet holding IBM blindly is not without risk. The company reported revenue declining 4%.
So, investors should consider other software companies that the market does not pay much attention to.
Investors should look at software stocks that have strong earnings growth prospects in the next year. If the stock is down from yearly highs or is on a downtrend, that is a bonus for investors looking for discounts. There are seven software stocks that investors should buy for growth. These firms offer unique solutions and therefore have moats.
Software Stocks to Buy: DocuSign (DOCU)
DocuSign (NASDAQ:DOCU) stumbled in August when the company issued a weak outlook. But when the company reported quarterly earnings on Sept. 5, it easily beat its downward guidance, sending the stock to 52-week highs. The company has a good chance of growing earnings per share by around 1.5 times and by 57% over the next five years. The stock is not cheap, trading at 13 times sales. DOCU has a market capitalization of around $11 billion.
DocuSign transforms the foundation of doing business by moving customers from paper-based document signing to electronic signatures. It had 537,000 customers as of July 31. Fiscal year 2019 revenue grew 35% year-over-year and could grow even faster since its total addressable market is $25 billion. The company previously stumbled when it added more features to its core offering. This increased the time needed to close deals. Customers needed to spend more time reviewing the bundled features before deciding to buy the solution.
DocuSign’s view on the handling of today’s paper agreement is that of a digital, connected, self-executing solution. Payment, customer relationship management and enterprise resource planning systems will handle all agreements in the future. With DocuSign unlocking the signing bottleneck, its customers complete deals more efficiently, saving everyone time. The firm has a web and mobile app with hundreds of millions of users. DocuSign is a rapidly-growing software firm with stock worth holding.
Okta (NASDAQ:OKTA) fell briefly below $100 in September. The company has a market cap of $12 billion. Analysts expect its EPS to grow 58% next year and 25% over the next five years. Piper Jaffray describes Okta as being in a class of its own after the company reported a good Q2/2020 earnings report. It lost 5 cents a share, though revenue grew 48.5% to $140.5 million. Okta enjoyed an exceptional quarter, lifted by subscription revenue growth of 51%, billings growth of 42% and remaining performance obligations growth of 68%. It added 450 new customers and now has 7,000.
After a 46% growth in customers with an annual contract value above $100,000, Okta now has 1,200 customers in that category. With strong recurring revenue and an acceleration in customer acquisitions, the company may sustain earnings growth above the 25% annual baseline.
In the last quarter, the company transitioned its offering from products to a component platform. That investment is paying off. It has a slew of new functionalities and products, such as Okta Advanced Server Access, that customers need. And since these features are still in their early phases, as customers buy more products from Okta, revenue growth will accelerate.
If revenue grows faster than markets expect, this is a stock in the software sector that investors should buy for growth.
For the last few months, ServiceNow (NYSE:NOW) traded in a tight trading range around $245-$270. When the company reports earnings next week, analysts expect the company to earn 88 cents a share on revenue of $885.8 million. Last quarter, ServiceNow reported subscription revenue of $781 million, up 33% year-over-year. The business was so robust that it increased its headcount to 9,382, up from 7,150 a year earlier. The company’s results benefited from winning several large deals in the financial services, technology and automotive industry that involved multiple IT products.
For full-year 2019, ServiceNow forecasts subscription billings between $3.74 billion and $3.75 billion, up 32% from last year. The most notable figures are its subscription gross margin expectations of 86% and its free cash flow margin of 28%.
The company added more than 700 employees in Q2, so expect sales numbers to get a strong push. As the marketing department gets better at promoting ServiceNow and accounts get bigger, investors may confidently raise their long-term expectations.
Customers find it easy to build on the ServiceNow platform, which is a clear strength of its business model. And because it is extensible, customers receive quick solutions. The company adds more technology through acquisitions, increasing the value of the platform. With this positive feedback loop, the company could reach a $10 billion revenue level in a few years.
Best known for its iPhones, Apple (NASDAQ:AAPL) stopped reporting unit sales last year. And for good reason. The company wants analysts to hone in on Apple’s services. In the third quarter, Apple reported record revenue of $11.5 billion from services, up 13% year-over-year. AppleCare, music, cloud services and its app store search advertising business are all positive contributors to service revenue. Even though music and ad sales is not really “software,” it is becoming the biggest source of revenue for Apple.
In the short term, investors will scrutinize Apple TV unit sales and subscription growth of its Apple TV+ offering. Yet investors may count on app sales, especially in China, for the next few years. EPS should grow 32.6% this year and 10% over the next five years. Solid sales of the iPhone 11 will lock in existing users to the Apple ecosystem. If Android users switch to an iPhone, that will help grow its services and software sales. AppleCare, Apple Music and cloud services are the three products more customers will willingly pay for. In the last quarter, services accounted for 21% of Apple’s revenue and 36% of gross margin dollars. If it keeps growing, expect gross margin to increase due to scale.
Credit card companies get to enjoy sky-high valuations but Apple Pay is growing at a healthy pace. It completed 1 billion transactions monthly, doubling the volume from last year. The service benefited from an Apple Pay launch in 17 countries in the June quarter.
On Oct 16, Citi downgraded Adobe (NASDAQ:ADBE) stock from a “buy” to “neutral.” Although the firm trimmed its price target slightly, the stock fell $10 on the day. The analysis is shortsighted: Adobe has virtually no competition and plenty of upside profit margin expansion ahead. Designers and media need Adobe’s suite of products and have no other real alternatives. For the next quarter, analysts expect Adobe to report EPS of $1.86. The company beat expectations in the last three consecutive quarters, so expect another beat in the next report.
In the last quarter, Adobe reported revenue of $2.8 billion, up 23.7% from last year. The record revenue is proof that its strategy to empower people to create and transform is paying off. Customers need to tell a story through design and creativity. So, they need Creative Cloud and Document Cloud software. Adobe reported net new digital media recurring revenue of $386 million. Total digital media ARR in Q3 topped $7.9 billion. The company has a goal of ensuring that Creative Cloud applications and services cover all its customers’ creative needs. Adobe Lightroom and Document Cloud sales should continue its positive sales momentum.
Adobe also saw strong growth for its single app offerings. Last quarter, apps like Adobe Premiere Pro for video and Adobe Illustrator contributed positively to the 40% year-over-year growth in international markets.
Workday (NASDAQ:WDAY) plunged by over 12% on Oct. 16 after the company’s Rising event ended. Although RBC cut its target price on the stock that day, markets may have grown cautious over its new products. Investors may reasonably expect slow initial sales and are unwilling to value the company at around the $40 billion market cap level. Even though EPS growth will decelerate, falling 21% this year, its EPS should rebound by 31% next year and 28.5% over the next five years.
In Q2, Workday said that over 40% of the Fortune 500 companies chose Workday for their core human capital management platform. As it expands globally, expect revenue growth to keep pace with historical rates. In the period, subscription revenue grew 34% to $757 million. Revenue outside of the U.S. rose 35% to $211 million and represented 24% of total revenue.
The continued global expansion will offset any potential slowdown in the U.S. market. Workday also said it will recognize the subscription revenue backlog growth of 28%, or $4.8 billion, in the next 24 months.
Workday warned that it faces tougher second-half comparable-store sales. Still, FY20 revenue will be near $3.1 billion, up 29% year-over-year. Q3 subscription revenue will grow 26% to between $783 million and $785 million.
WDAY stock peaked in July and is on a sustained downtrend. Wait for the selling pressure to ease and consider buying this software stock.
With an EPS set to grow 38.8% this year and 63% next year, Autodesk (NASDAQ:ADSK) fell sharply in late July but rebounded slightly after its Q2/2020 report. It earned 65 cents a share as revenue rose 30.3% to $796.8 million. How is this software company driving strong organic growth?
Autodesk is growing organic cloud ARR through BIM 360. It is integrating its product and maximizing cross-selling opportunities. In the manufacturing sector, a challenging macro environment did not prevent the software company from growing manufacturing revenue by 20%. This was helped by Fusion 360’s integrated functionality and competitive pricing.
Autodesk expects total ARR will grow 25%-27% in FY20, to $3.5 billion. And even though ADSK stock is trending lower, billings will grow 49%-51% to $4.1 billion. Next fiscal year, recurring revenue as a percentage of the total will be in the mid 90% range. Although revenue will fall in the second half of FY20, gross margins will rise, due to revenue growth for the year.
Strong demand for AutoCAD LT and continued strength across all regions suggests sustainable growth beyond the fiscal year. Macro worries due to the ongoing trade war may hit the manufacturing sector but so far, Autodesk is immune to this risk.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.