Will Software Stocks Continue to
Move Higher?
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Technology stocks that make up the hardware portion of the market have not
been so hot recently. Intel was trading as high as $95 within the last 3 weeks
and has fallen to $77. When they announced that earnings would not meet
upcoming expectations, as the whole world knows, their stock was beaten to
a crisp along with the whole technology sector that day. According to the
Goldman Sachs Semiconductor Index, Semiconductors have not done
much in the way of returns since mid October of 1997. Another sector that
has been hit is the companies that make computer hardware. The Goldman
Sachs Computer Hardware Index has also been in the doldrums since last
October. On the positive side the Goldman Sachs Computer Software
Index has been going up and making new highs. Is this a trend that is
developing for technology stocks? Rich Scocozza, a software analyst at
Bear Stearns notes, that software stocks have clearly outperformed
technology stocks as a whole and that the software business is the place to
be.
"What you are seeing now is a shift in spending to software and business
applications from the more traditional infrastructure type hardware... As
computing environments continue to mature, you are going to see less
spending on the nuts and bolts and more spending on the software which is
what ultimately counts," he says. He interestingly points out that if you look
today at overall technology spending generally 75% is spent on infrastructure
and 25% is spent on applications. "The reality is that it should be flipped
around. I think that is the model that companies want to move to where most
of their IT (Information Technology) dollars are getting spent on things that
help improve customer service, productivity, order cycle time and help them
get better information to make strategic decisions. You may need more
software to support them, but I believe the software business is what is driving
this whole thing. There is incredible cost cutting pressure on the PC side of the
business and we have not seen that in the software business," says Rich
His favorite is Legato Systems
He feels that American businesses are starting to focus on a new round of cost
cutting & efficiency and the enterprise software is allowing them to do this.
Some of his favorite stocks include Legato Systems, PeopleSoft,
Computer Associates and Microsoft. His favorite is Legato Systems
(LGTO 28 1/16). Legato competes in the enterprise storage management
market, which is growing at a very rapid rate and is estimated to expand by
55% or better annually over the next few years. "Legato has the best
products in that market place. There is minimal competition in that space right
now. They are trading at discount to its long term growth rate of 45%. Just
looking at 35 times our fiscal 99 earnings estimate you get up to $32, that is
very conservative. In reality it can trade up to 40 times fiscal 99. I am
confident it can get up into the high 30's," says Rich.
Bruce Lupatkin, Director of Research at Hambrect & Quist, likes the
fundamental long term trends for technology stocks. He feels that the U.S.
economy is being restructured with the help of technology companies. He
believes that the PC box space is fairly mature but the software arena has
many "new architectures and automation" products.
One must remember that software will not run without the proper hardware to
put it on. The hardware industry is going through a transition period of cost
cutting and consolidation. Eventually, the hardware companies will have their
day again but not without more price cuts and consolidation. At this point in
time, it is hard point a finger in which direction the hardware companies will
move. Right now the finger is pointing towards volatile hardware markets as
consolidation and cost cutting remains the trend. Many software companies
trade at very lofty price to earnings ratios right now so, that is a downside
factor for them. Short term, software stocks are ripe to take a breather but
the longer term theme remains in place. The good news is that the demand for
software will continue as companies look for ways to cut costs and improve
productivity. The software will always need hardware to run on but more
money (from consumers) will continue to shift from the hardware side to the
software side.
Mark Johnson Editor IFC
Will software stocks continue higher? Some will! Heh heh. |
