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Stock Strategist Industry Reports

Sifting Through the Software Storm

We see long-term opportunities developing in some of our wide-moat companies.

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Software companies' shares have taken a beating over the past several weeks, catalyzed by subpar earnings from a number of highfliers, most notably  Tableau Software (DATA) and  ServiceNow (NOW). While these stocks have suffered the steepest declines, we believe several high-quality names have been thrown out with the bathwater, creating investment opportunities. In particular, wide-moat  Adobe Systems (ADBE) and  Guidewire Software (GWRE) are trading at meaningful discounts to our fair value estimates, and although we expect volatility to persist in the near term, we believe they look attractive. In our view, Adobe's successful transition to the cloud and subsequent investment in its marketing cloud platform will yield significant growth opportunities in markets where we believe the firm holds a competitive advantage. Guidewire has become the premier vendor for legacy software replacements among property and casualty insurers, having inked deals with nearly half of the world's largest insurance companies. Its solutions are mission-critical to the policy lifecycle, and the firm has the ability to increase lifetime customer value through cross-selling to additional business lines and upselling add-on applications. Adobe's and Guidewire's shares are trading at enterprise value/sales multiples not seen in more than two years, creating a compelling entry point for two companies poised for solid long-term growth.

We view Adobe as the gold standard for companies transitioning from an on-premises to cloud-based delivery model. While its forced migration caught many off guard, the firm has successfully navigated this transition, in our view, with more than 6 million Creative Cloud subscribers as of December 2015. These software products are critical to the creative community and serve a number of professions, from photographers and videographers to video game developers and graphic designers. Adobe's transition to the cloud should help reaccelerate consolidated top-line growth over the next several years by virtually eliminating upgrade and piracy risk that was prevalent under the license model, while simultaneously attracting new customers to the platform through more attractive pricing terms and tailored software packages, such as the existing photography package combining Photoshop and Lightroom.

Rodney Nelson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.