Software stocks surging forward would partly explain the Nasdaq’s monumental all-time highs achieved recently. Much of the fundamentals shifted for the better when the world suddenly found the need for remote work.
The sharp increase in coronavirus infections in the U.S. following relaxed rules for social distancing also drives home a key point. Companies, especially in the technology space like Facebook (NASDAQ:FB), Twitter (NASDAQ:TWTR), and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) are telling most staff to work from home indefinitely.
Markets already rewarded companies that supply remote software solutions. But because this trend will only increase as software stocks have a good chance of climbing to new highs. Value investors will avoid most of the stocks that will be discussed. Conversely, savvy investors who have a good grasp of the revenue growth potential in business models with software subscriptions will want to read on.
There are seven software stocks that investors should watch closely:
- Datadog (NASDAQ:DDOG)
- Shopify (NYSE:SHOP)
- ServiceNow (NYSE:NOW)
- ZoomInfo Technologies (NASDAQ:ZI)
- Fastly (NYSE:FSLY)
- Square (NYSE:SQ)
- PagSeguro Digital (NYSE:PAGS)
Software Stocks to Buy: Datadog (DDOG)
First up on this list of software stocks is Datadog. Datadog continued surging after posting solid first-quarter results. Revenue grew an astounding 87% year-over-year to $131 million. The company nearly doubled its larger customer base.
For example, it now has 960 customers with an average recurring revenue (ARR) of $100,000, up from 508 last year. CEO Olivier Prmel said that “In response to the COVID-19 pandemic, we are focused on ensuring the safety of our employees, continuing to best serve our customers, and investing in our platform.”
Data courtesy of Stock Rover Research
In the above bar chart, DataDog just completed its seasonally strong return period. Other than in November, potential returns are mixed.
On June 17, the company announced an integration deal with Amazon Elastic File Service. This helps the customer adopt to serverless workflows. Datadog also uses EFS and Amazon Web Service Lambda to help its customers “plan and track their maintenance.” Its strong product offering and growing customer base suggest that Datadog will sustain its revenue growth for at least the current year.
Datadog stock may come down a bit if investors grow nervous over its price-to-sales multiple of over 60 times. But the strong outlook suggests the stock will bounce back quickly.
Shopify enjoys the biggest market capitalization in its home country of Canada. The pandemic caught the attention of one analyst who set a price target of $1,000. On June 18, the RBC Capital Markets analyst said the market did not appreciate Shopify’s total addressable market.
Shopify stock has an unfavorable value score of 55/100. That is not stopping markets from bidding shares higher:
|Price / Earnings||–||–||27.4|
|Price / Sales||67.1||8.9||2.3|
Shopify hardly ever lost money for investors in any given month. October is its only under-performing month:
CChart courtesy of Stock Rover
Walmart (NYSE:WMT) joined forces with Shopify “to open the Walmart Marketplace to their sellers.” The deal re-affirms Shopify’s dominance in helping eCommerce businesses in the U.S. This grew 74% alone in the last quarter, probably due to the pandemic. Small businesses that relied on a physical storefront could not open, forcing them to start an online presence. This suggests that the second quarter will beat first-quarter results.
In Q1, Shopify posted revenue growth of 46.7% Y/Y to $470 million. Non-GAAP EPS was 19 cents (but a loss of 27 cents EPS on a GAAP basis). Gross merchandise volume (GMV) was $17.4 billion, up sharply from $11.9 billion last year.
ServiceNow earned $1.05 a share (non-GAAP) as revenue grew 34% Y/Y to $1.06 billion in the first quarter. The NOW ticker should be renamed to “WOW” because the company added 37 transactions of over $1 million in new net annual contract value. This is up 48% Y/Y.
The company’s CFO, Gina Mastantuono, said “we continue to focus on customer-driven innovation and remain confident in our path to $10 billion in revenue and beyond.”
On its conference call, CEO Bill McDermott said “we’re studying very carefully, especially in the COVID environment, what we can do to help them.” So, the company is protecting its revenue base by developing a business continuity plan with its customers. If the world ever goes back from virtual to physical, ServiceNow will not face a slowdown in its business.
ZoomInfo Technologies (ZI)
As a recent post-IPO, ZoomInfo Technologies is already enjoying a trajectory upward. ZI stock popped 90% from its $21 IPO price when it debuted on the markets on June 4, 2020.
The company operates a business intelligence platform. It provides businesses with data intelligence analysis in return for subscription revenue. But smaller businesses cannot afford to pay as much as big companies. So, ZoomInfo’s offering is appealing. By disrupting the market, ZI stock is rising because it creates more revenue sources. Investors are betting that the company will win more small business customers in the quarters ahead.
Conservative investors should not ignore ZoomInfo’s rich valuations. Any market correction would hurt the stock price but create a better entry point for those who missed the rally.
Just as the company name suggests, Fastly is on a tear after falling to $10.63 in March 2020. Even after the company took advantage of the rally by pricing a follow-on public offering of 6 million shares at $41.50, the stock kept rising. The cash raised will give the company more resources to invest in the business to fuel further growth.
In the first quarter, Fastly reported a GAAP EPS loss of 13 cents. Revenue grew 37% Y/Y to $63 million. CEO Joshua Bixby said:
These unprecedented times highlight the importance of digital transformation now more than ever, and our innovative and resilient customer base enables us to remain confident in the demand for our mission-critical services and the accelerated growth of our business.
Lately, markets rewarded digital transformation providers like Fastly with high valuations with expectations of faster growth ahead.
The company highlighted the site’s platform suits a customer base driven with innovation. For example, those digital transformers will continue to drive demand and increase Fastly’s revenue. Bixby said that “as a system built by developers for developers, we are uniquely positioned to capture that inspiration and to serve the best of the web.”
Be warned that analysts have a downside price target of around $42, a 50% downside risk (per Tipranks).
Square broke above 52-week highs in the last few weeks as investors bet on a strong rebound in retail and software stocks. The pandemic shut down most retailers since March. But when they reopened again, markets bought any e-transaction companies, including Square stock.
Revenue could surge in the current quarter but there are risks. Small and medium-sized businesses slowed down too much for Square to report a year-on-year increase in transactions. Still, Cash App’s total payment volume (TPV) may have recovered back to pre-COVID-19 levels. With pent up demand, TPV may have grown at a better pace than expected. When Square reports quarterly results next month, a revenue and earnings beat may lift the stock to new highs for the year.
Competitor Mastercard (NYSE:MA) and Visa (NYSE:V) also recovered from March lows but Square stock outperformed both of them on a year-to-date basis. On average, the 26 analysts covering Square have a price target of around $89 (per Tipranks).
PagSeguro Digital (PAGS)
PagSeguro Digital, based in Sao Paulo, reported revenue growth 26.9% from last year. Net income grew 15.2%, despite the COVID-19 pandemic. TPV grew by 30% Y/Y as did its active merchant basis. With R$1,404 million in cash and cash equivalents, the company may weather any potential slowdown.
The company describes itself as “a disruptive provider of financial technology solutions focused primarily on consumers, individual entrepreneurs, micro-merchants, small companies, and medium-sized companies in Brazil.” It is a financial technology provider in digital banking, point of sale devices, credit cards, prepaid, and cash issuance.
PagSeguro’s launch of a virtual shopping format, PagPerto, will let its sellers offer a digital product catalog. This will lower marketing costs for customers and match sellers with buyers. The format will also support shopping vouchers, called “vale-compras,” which should drive shopping volumes higher.
On that same month of April 2020, the company launched PagBank Health. In troubled pandemic times, expect volumes surging for medical exams, setting up pharmacy purchases, and doctor’s appointments.
In a 5-year discounted cash flow growth exit model, at a perpetuity growth rate of 4%, PAGS stock has a fair value of ~$48 (per finbox.com).
As of this writing, the author did not hold a position in any of the aforementioned securities.