The Zacks Business-Software Services industry is benefiting from the heightened demand for digital transformation and the ongoing shift to the cloud. The growing automation of business processes across multiple industries and rapidly increasing enterprise data volumes are also driving the demand for business software and services.     The growing demand for solutions that support hybrid operating environments is noteworthy. Increasingly sophisticated cyber-attacks are driving cybersecurity application demand. Robust IT spending on software is an upside for industry participants. Industry participants like MSCI MSCI, Cognizant Technology Solutions Corporation CTSH, Tyler Technologies TYL and Guidewire Software GWRE are gaining from these trends.

However, heightened geopolitical risks, still-high interest rates and protracted inflationary conditions are major headwinds. Elevated operating expenses related to hiring new employees, and sales and marketing strategies to capture more market share are likely to strain margins in the near term.

Industry Description

The Zacks Business-Software Services industry primarily comprises companies that deliver application-specific software products and services. The applications are typically either license-based or cloud-based. The offerings generally include applications related to finance, sales & marketing, human resources and supply chain, among others. The industry consists of a broad range of companies offering a wide range of products and services, including business processing and consulting, application development, testing and maintenance, office productivity suits, systems integration, infrastructure services and network security applications. Some companies provide investment-decision support tools. Manufacturing, retail, banking, insurance, telecommunication, healthcare and public sectors are the primary end markets for industry participants.

5 Trends Shaping the Future of the Business-Software Services Industry

Transition to Cloud-Creating Opportunities: Companies in this industry have been gaining from the robust demand for multi-cloud-enabled software solutions, given the ongoing transition from legacy platforms to modern cloud-based infrastructure. These industry players are incorporating artificial intelligence (AI) into their applications to make the same more dynamic and result-oriented. Most industry players are now offering cloud-based versions of their solutions in addition to on-premise ones, expanding content accessibility. Enhanced interoperability features provide customers with differentiation and efficiency.

Subscription Model Gains Traction: The industry participants are modifying their business models to cope with clients’ shifting requirements. Subscription and term license-based revenue pricing models have become highly popular and are now replacing the legacy upfront payment prototype. Subscription-based business models provide increased revenue visibility and higher recurring revenues, which bode well for companies over the long haul. However, due to this transition, the top-line growth of these companies might be affected in the days to come as term-license revenues include advance payments, whereas subscription-based revenues are a bit delayed.

Continuous M&A to Expand Product Offerings: The players in this industry are resorting to frequent mergers and acquisitions to supply complementary and end-to-end software products. However, increasing investments in digital offerings and acquisitions might erode the industry’s profitability in the upcoming period.

Optimistic IT Spending Forecast: The latest forecast for worldwide IT spending by Gartner is an upside for industry participants. The worldwide IT spending is anticipated to increase 7.5% to $5.26 trillion in 2024. The research firm expects worldwide spending on software to grow 13.9% year over year in 2024.

Elevated Operating Expenses to Hurt Profitability: To survive in the highly competitive business software market, each player is continuously investing in broadening its capabilities. The players in the space are aggressively investing in research and development to enhance their product portfolios. Moreover, companies are investing heavily to boost their sales and marketing capabilities, particularly by increasing their sales force. Elevated operating expenses to capture more market share are likely to dent margins in the near term.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Business-Software Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #27, which places it in the top 11% of more than 250 Zacks industries.

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

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of the positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are optimistic about this group’s earnings growth potential.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Underperforms S&P 500 and Sector

The Zacks Business-Software Services industry has underperformed the S&P 500 Index as well as the broader Zacks Computer and Technology sector’s performance over the past year.

The industry has soared 31.6% during this period, while the broader sector and the S&P 500 have risen 39.6% and 33.9%, respectively.

One-Year Price Performance

Industry's Current Valuation

Comparing the industry with the S&P 500 composite and the broader sector on the basis of the forward 12-month price-to-earnings, which is a commonly used multiple for valuing business-software services stocks, we see that the industry’s ratio of 29.2 is higher than the S&P 500’s 21.57 and the sector’s 25.99.

Over the last five years, the industry has traded as high as 36.71X and as low as 20.53X and recorded a median of 25.95X, as the charts below show.

4 Business-Software Services Stocks in Focus

MSCI: The company offers investment decision support tools, including indexes, portfolio construction and risk management products and services, Environmental, Social and Governance (“ESG”) research and ratings and real estate research, reporting and benchmarking offerings.

MSCI’s prospects are benefiting from the strong demand for custom and factor index modules, recurring revenue business models and the growing adoption of its ESG and Climate solutions in the investment process. MSCI’s expanding portfolio of real asset solutions is noteworthy. The company’s strategic partnerships, including the one with Moody’s, expanded its ESG and sustainability coverage, while its new MSCI AI Portfolio Insights tool and recent acquisitions, such as Foxberry, bolstered its capabilities in custom indexing and AI-driven analytics. Strong traction from client segments like wealth management, banks and hedge funds is an upside.

Shares of this Zacks Rank #2 (Buy) company have increased 4% year to date (YTD). The Zacks Consensus Estimate for 2024 earnings has moved a penny north to $14.79 per share over the past 60 days. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Tyler Technologies: This Zacks Rank #2 company is a leading provider of integrated information management solutions and services to the public sector. Tyler serves its customers both on-premise and in the cloud.

Tyler is benefiting from higher recurring revenues, post-acquisition contributions of NIC and the rebound of market and sales activities to pre-COVID-19 levels. The public sector’s ongoing transition from on-premise and outdated systems to scalable cloud-based systems is an upside. The growing hybrid working trend is also driving the demand for its connectivity and cloud services. Its strong liquidity position is helping it pursue acquisitions, which are expected to continue to drive growth.

Shares of this Plano, TX-based company have soared 39% YTD. The Zacks Consensus Estimate for 2024 earnings has been revised upward by 3 cents to $9.36 per share over the past 60 days.

Cognizant: It is a leading professional services company. Its services include digital services and solutions, consulting, application development, systems integration, application testing, application maintenance, infrastructure services and business process services.

Cognizant is benefiting from a robust product pipeline that includes a favorable mix of new opportunities. Acquisitions are contributing to top-line growth. An improved attrition rate bodes well for Cognizant. Continued strength among logistics, utility, travel and hospitality customers is a plus. Its strong momentum in securing large deals is a major upside. An expanding clientele due to growing partnerships with companies like Microsoft, NVIDIA, Shopify, Alphabet, McCormick & Company and Telstra has been a tailwind. It expects the NextGen initiative to help expand margins in the long haul.

CTSH, which currently carries a Zacks Rank #3 (Hold), has increased 1.3% YTD. The consensus mark for 2024 earnings has been revised a penny downward to $4.62 per share in the past 30 days.

Guidewire Software: This San Mateo, CA-based company is a provider of software solutions for property and casualty insurers. The company's solutions aid in reducing risks via increased productivity, bringing speed to market, digital engagement and simplifying the IT infrastructure.

Guidewire is gaining from solid Tier-1 deal volume and increasing migration activity, especially in the Asia-Pacific. Guidewire Cloud gained momentum with 16 cloud deals in the fourth quarter of fiscal 2024, taking the total cloud wins to 42 for the full fiscal. Margin performance is powered by cloud infrastructure efficiency.  A solid balance sheet and a robust SI partner ecosystem are major tailwinds. The company is likely to benefit as insurers modernize their legacy mainframe systems and replace previously modernized on-premise systems. Also, GWRE’s share repurchase program is noteworthy. Strategic acquisitions and collaborations, along with a less competitive market and a strong liquidity position, bode well.

Shares of this Zacks Rank #3 company have risen 67.1% in the YTD period. The consensus mark for fiscal 2025 earnings is pegged at $1.97 per share, revised 2 cents upward over the past seven days.

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MSCI Inc (MSCI) : Free Stock Analysis Report

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