Software is eating the world, and virtually no business is left untouched by it. This secular theme makes SaaS companies attractive investment candidates but also comes with higher valuations that make re-ratings harder. Unfortunately, the rich prices have held them back over the past six months as the industry’s gain of 3.7% has fallen short of the S&P 500’s 9.7% rise.
A cautious approach is imperative when dabbling in these businesses as the best will deliver robust earnings growth while the rest will be disrupted by competition and AI. With that said, here is one software stock boasting a durable advantage and two that may face trouble.
Two Software Stocks to Sell:
Unity (U)
Market Cap: $16.65 billion
Powering over half of the world's mobile games and expanding into industries from automotive to architecture, Unity (NYSE: U) provides software tools and services that allow developers to create, run, and monetize interactive 2D and 3D content across multiple platforms.
Why Does U Worry Us?
- Customers had second thoughts about committing to its platform over the last year as its billings averaged 6% declines
- Long payback periods on sales and marketing expenses limit customer growth and signal the company operates in a highly competitive environment
- Suboptimal cost structure is highlighted by its history of operating margin losses
Unity’s stock price of $39.32 implies a valuation ratio of 8.7x forward price-to-sales. If you’re considering U for your portfolio, see our FREE research report to learn more.
Varonis Systems (VRNS)
Market Cap: $6.37 billion
Beginning with protecting Windows file shares in 2005 and evolving into a comprehensive security platform, Varonis Systems (NASDAQ: VRNS) provides data security software that helps organizations protect sensitive information, detect threats, and comply with privacy regulations.
Why Are We Cautious About VRNS?
- Sales trends were unexciting over the last three years as its 11% annual growth was below the typical software company
- Historical operating margin losses point to an inefficient cost structure
- Capital intensity will likely increase as its free cash flow margin is anticipated to drop by 3 percentage points over the next year
Varonis Systems is trading at $56.51 per share, or 9.3x forward price-to-sales. Check out our free in-depth research report to learn more about why VRNS doesn’t pass our bar.
One Software Stock to Buy:
Cloudflare (NET)
Market Cap: $72.5 billion
With a massive network spanning more than 310 cities in over 120 countries, Cloudflare (NYSE: NET) provides a global network that delivers security, performance and reliability services to protect websites, applications, and corporate networks.
Why Will NET Beat the Market?
- Billings growth has averaged 30.3% over the last year, indicating a healthy pipeline of new contracts that should drive future revenue increases
- Market share will likely rise over the next 12 months as its expected revenue growth of 26.3% is robust
- Software platform has product-market fit given the rapid recovery of its customer acquisition costs
At $208.50 per share, Cloudflare trades at 30.4x forward price-to-sales. Is now the right time to buy? See for yourself in our full research report, it’s free.
Stocks We Like Even More
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