3 Internet Software Stocks to Buy in a Challenge Industry

The Zacks Internet Software industry is suffering from increased geopolitical risks due to the Russia-Ukraine conflict, higher wage inflation, currency fluctuations and pandemic-induced supply-chain disruptions. However, industry participants like Paylocity Holding PCTY, PayPal PYPL and Model N MODN are benefiting from accelerated demand for digital transformation and the ongoing shift to the cloud. The high demand for SaaS-based solutions due to the increasing need for remote working, learning and diagnosis software as well as cybersecurity applications has been a major driving factor. The growing demand for solutions that support hybrid operating environments is noteworthy. Robust IT spending on software is a positive factor for industry participants.

Industry Description

The Zacks Internet Software industry comprises companies offering application performance monitoring as well as infrastructure and application software, DevOps deployment and Security software. Industry participants offer multi-cloud application security and delivery, social networking, online payment, and 3D printing applications and solutions. The industry participants use the SaaS-based cloud computing model to deliver solutions to end-users as well as enterprises. Hence, subscriptions are the primary source of revenues. Advertising is also a major revenue source. Industry participants target a variety of end-markets, including banking & financial services, service providers, federal governments and animal-health technology and services.

3 Trends Shaping the Future of the Internet Software Industry

Growing Adoption of SaaS: The industry is benefiting from continued demand for digital transformation. Growth prospects are alluring primarily due to the rapid adoption of SaaS, which offers a flexible and cost-effective delivery method of applications. It also cuts down on deployment time compared to legacy systems. SaaS attempts to deliver applications to any user, anywhere, anytime and on any device. It has been effective in addressing customer expectations of seamless communications across multiple channels, including voice, chat, email, web, social media and mobile. This drives customer satisfaction and increases retention rate, thereby driving the top line of industry participants. Moreover, the SaaS delivery model has supported industry participants to deliver software applications amid coronavirus-led lockdowns and shelter-in-place guidance. Remote working, learning and diagnosis also have boosted demand for SaaS-based software applications.

Pay-As-You-Go Model Gaining Traction: The increasing customer-centric approach is allowing end-users to perform all the required actions with minimal intervention by the software provider. Moreover, the pay-as-you-go model helps Internet Software providers scale their offerings according to the needs of different users. Further, the subscription-based business model ensures recurring revenues for industry participants. The affordability of the SaaS delivery model, particularly for small and medium businesses, is also a major driver. The cloud-based applications are easy to use. Hence, the need for specialized training reduces significantly, which lowers expenses, thereby driving profits.

Ongoing Transition to Cloud Creates OpportunitiesAdditionally, the growing need to secure cloud platforms, amid the growing incidence of cyber-attacks and hacking, drives demand for web-based cyber security software. Further, as enterprises continue to move their on-premise workload to cloud environments, application and infrastructure monitoring is gaining importance. This is creating more demand for web-based performance management monitoring tools.

Zacks Industry Rank Indicates Dim Prospects

The Zacks Internet Software industry, within the broader Zacks Computer And Technology sector, carries a Zacks Industry Rank #138 that places it in the bottom 45% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is the average of the Zacks Rank of all the member stocks, indicates dull near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Despite the gloomy industry outlook, a few stocks have the potential to outperform the market. But before we present the top industry picks, it is worth looking at the industry’s shareholder returns and current valuation first.

Industry Lags Sector and S&P 500

The Zacks Internet Software industry has underperformed the broader Zacks Computer And Technology sector as well as the S&P 500 Index in the past year.

The industry has declined 59.7% over this period against the S&P 500 Index’s decline of 6.9% and the broader sector’s decline of 22.5%.

One-Year Price Performance

Industry’s Current Valuation

On the basis of trailing 12-month price-to-sales (P/S), which is a commonly used multiple for valuing Internet software stocks, we see that the industry is currently trading at 2.22X compared with the S&P 500’s 3.93X and the sector’s trailing 12-month P/S of 3.82X.

Over the last three years, the industry has traded as high as 5.25X, as low as 1.78X and at the median of 2.79X, as the chart below shows.

Trailing 12-Month Price-to-Sales (P/S) Ratio

3 Stocks to Buy Right Now

Paylocity Holding – This Illinois-based Zacks Rank #2 (Buy) company offers cloud-based payroll and human capital management software solutions to medium-sized organizations across the United States. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Paylocity is benefiting from the growing adoption of its solutions among clients with less than 50 employees. Healthy momentum in the company’s core and upper end of the market is a tailwind. The release of the Learning Management System and Community portal, which garnered positive feedback from clients, is encouraging. Also, the addition of on-demand pay to her portfolio is likely to boost client wins in the long haul.

Paylocity’s stock has increased 5.2% year to date. The Zacks Consensus Estimate for its fiscal 2023 earnings is pegged at $3.58 per share, up 14.7% in the past 30 days.

Price and Consensus: PCTY

PayPal – This Zacks Rank #2 (Buy) company is benefiting from strong growth in total payments volume owing to increasing net new active accounts. Strengthening customer engagement is a positive. Also, strong performance by Venmo is contributing well to the total payment volume growth.

Solid momentum across peer-to-peer and PayPal Checkout experiences is a tailwind. Further, PayPal’s growing traction in the United States remains a major positive.

PYPL shares have declined 50.4% year to date. The Zacks Consensus Estimate for 2022 earnings has increased 1% to $3.92 per share over the past 30 days.

Price and Consensus: PYPL

Model N – A solid go-to-market strategy, new logo additions and robust sales execution are driving Model N’s top-line growth. The company continues to witness strong contributions from subscription booking across its portfolio. It also successfully witness strong subscription sales.

Shares of this Zacks Rank #2 company have returned 1.6% year to date. The Zacks Consensus Estimate for Model N’s fiscal 2022 earnings stands at 70 cents per share, up 22.8% in the past 30 days.

Price and Consensus: MODN

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PayPal Holdings, Inc. (PYPL): Free Stock Analysis Report

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