Bear Stearns Upgrades Software Sector: 'Valuations in Line With a Maturing Industry'

Bear Stearns software analyst John Difucci upgraded his stance Friday morning on the software sector to Market Weight from Underweight, noting that “valuations have come more in line with a maturing industry.”

DiFucci says that while the industry is maturing, “it should still trade at a greater multiple than the market, given software’s flexibility since it is based on intellectual assets versus fixed assets that provide the foundation for many industries.”

On the other hand, DiFucci cautions that the stocks may not get the end-of-the-year rally some investors are anticipating. For one thing, he says the industry’s seasonality “is now well understood and anticipated by investors, and is likely reflected in technology stock prices.” He also notes that in the post-bubble years, year-end software outperformance generally followed weak performance earlier in the year - something that did not happen this time.

Another factor, he notes, is that 20% of software spending comes from the financial services industry. “Given the issues being experienced by the financial services vertical,” he writes, “we believe that investors and analysts should elevate this reality in considering software investments. While we have heard little impact as of yet, we would not be shocked to see discretionary spending on new projects delayed or perhaps even canceled if the issues continue to escalate.

On a more positive note, he points out that the sector has been getting an earnings boost from the weak dollar, and DiFucci notes that the sector is also seeing improved IT spending in Western Europe. And he says consolidation will likely continue to provide support for the stock.

In the end, he says, “it all cones down to valuation” - and he notes that right now the P/E on the S&P software index is in the lower half of its historical range relative to the S&P 500.

Comments

[Sr. Pessimist:]

Software has changed. Smaller guys have bigger impact. The industry rewards agility. And, ommm, it's changed pretty big in another way. It used to be that you could hide what you do to a reasonable degree. Now that's not true. Modern encryption doesn't work. That means two things here and now. First thing is you can't tell your customers their credit card and banking information is secure. It is not. It is authentic at best, and confidentiality is a delusion of the past. Second, authentication is inherently stronger. Nobody- and I mean NOBODY- can hide who they are online. So there's less crap the big guys can get away with to stay big. So the smaller guys have a bigger impact. That's because the only reason the rich stay rich is because they get away with committing crimes against the poor (like Google engaging in anticompetitive practices against small guys or doctors committing evil malpractice on their patients and lobby-bribing for statutes of limitations laws). But now online there's evidence of every move. So the rush is to provide the greatest authentication possible to prevent illegitimates from hurting your customers' finances.

2007 Aug 20 10:35 PM