Software has become an integral part of an organization’s success. With growing investments in digitization, the demand for software applications has increased significantly. Integrating generative AI into software applications is expected to further boost the industry’s prospects.

However, not all companies in this category are well-positioned to benefit from the tailwinds. Commission-free investing and trading platform provider Robinhood Markets, Inc. (HOOD), which belongs to the broader software industry, could witness a downside because of its weak fundamentals. Therefore, one could invest in quality software stocks such as Adobe Inc. (ADBE), Salesforce, Inc. (CRM), and eGain Corporation (EGAN) instead.

Before diving deeper into the fundamentals of these stocks, let’s look at what’s shaping the software industry’s prospects and why HOOD must be avoided.

The growth of business application software has been astonishing. With significant investments in digitization, the demand for business application software has grown. Additionally, the integration of generative AI into business applications, such as productivity suite, Customer Relationship Management (CRM), etc., is expected to boost efficiency and productivity.

Gartner forecasts software spending to increase 13.7% year-over-year to $922.75 billion. Gartner’s Distinguished VP Analyst John-David Lovelock said, “Generative AI’s best channel to market is through software, hardware, and services that organizations are already using. Every year, new features are added to tech products and services as add-ons or upgrades.”

“Most enterprises will incorporate generative AI in a slow and controlled manner through upgrades to tools that are already built into IT budgets,” he added.

HOOD managed to top the consensus EPS and revenue estimates in the second quarter. Its EPS was $0.04 higher than analyst estimates, while its revenue beat the Street estimate by 1.8%. For the second quarter ended June 30, 2023, HOOD’s transaction-based revenues declined 4% year-over-year to $193 million. However, its total net revenues rose 53% year-over-year to $486 million.

The company reported a net income of $25 million, compared to a net loss of $295 million in the prior year quarter. Similarly, its EPS came in at $0.03, compared to a loss per share of $0.34 in the year-ago quarter. This was the first time the company achieved GAAP profitability as a public company.

However, HOOD trades at an expensive valuation. In terms of forward non-GAAP P/E, HOOD’s 26.50x is 193.4% higher than the 9.03x industry average. Likewise, its 5.18x forward Price/Sales is 127.1% higher than the 2.28x industry average. Its 1.35x forward Price/Book is 37.5% higher than the 0.98x industry average.

Similarly, its profitability is weaker than its peers. HOOD’s trailing-12-month net income margin is negative 49.58% compared to the 25.89% industry average. Likewise, its trailing-12-month Return on Common Equity is negative at 11.64% compared to the 11.40% industry average. Furthermore, the stock’s 0.54% trailing-12-month Capex/Sales is 73.1% lower than the industry average of 2.01%.

Having looked at the reasons why HOOD must be avoided, let’s look at the fundamentals of the three best Software – Application stocks, beginning with number 3.

Stock #3: Adobe Inc. (ADBE)

ADBE operates as a diversified software company. It operates through three segments: Digital Media, Digital Experience, and Publishing and Advertising.

On March 21, 2023, ADBE introduced Adobe Firefly, a creative, generative AI model that generates images and text effects.

ADBE’s Digital Media Business President David Wadhwani said, “With Firefly, Adobe will bring generative AI-powered ‘creative ingredients’ directly into customers’ workflows, increasing productivity and creative expression for all creators from high-end creative professionals to the long tail of the creator economy.”

In terms of the trailing-12-month EBITDA margin, ADBE’s 37.03% is 309.7% higher than the 9.04% industry average. Likewise, its 37.59% trailing-12-month levered FCF margin is 435.4% higher than the industry average of 7.02%. Furthermore, its 0.68x trailing-12-month asset turnover ratio is 10.3% higher than the 0.62x industry average.

ADBE’s total revenue for the second quarter ended June 2, 2023, increased 9.8% year-over-year to $4.82 billion. Its net cash from operating activities rose 4.9% over the prior-year quarter to $2.14 billion. The company’s non-GAAP operating income increased 10.4% year-over-year to $2.18 billion.

In addition, its non-GAAP net income increased 13.2% over the prior-year quarter to $1.79 billion. Also, its non-GAAP EPS came in at $3.91, representing an increase of 16.7% year-over-year.

Its EPS and revenue for the quarter ending August 2023 are expected to increase 16.8% and 9.8% year-over-year to $3.97 and $4.87 billion, respectively. It surpassed the consensus EPS estimates in each of the trailing four quarters. Over the past nine months, the stock has gained 71.6% to close the last trading session at $560.46.

ADBE’s POWR Ratings reflect solid prospects. It has an overall rating of B, equating to a Buy in our proprietary rating system. The POWR Ratings assess stocks by 118 different factors, each with its own weighting.

Within the Software – Application industry, it is ranked #30 out of 136 stocks. It has an A grade for Quality and a B for Sentiment. Click here to see the additional ratings of ADBE for Growth, Value, Momentum, and Stability.

Stock #2: Salesforce, Inc. (CRM)

CRM is a cloud-based software company. It provides Customer Relationship Management (CRM) technology that brings companies and customers together worldwide. The company’s CRM software and application focus on sales, marketing automation, customer service, e-commerce, and analytics.

On June 29, 2023, CRM announced that it would invest $4 billion in its UK business over the next five years. Salesforce UKI’s CEO Zahra Bahrololoumi said, “A clear pro-innovation regulatory framework that compels safe and responsible use of AI is vital, and Salesforce is fully focused on bringing secure, trusted, enterprise-ready generative AI to UK businesses.”

On March 7, 2023, CRM announced the launch of Einstein GPT. This first generative AI CRM technology delivers AI-created content at a hyper-scale level across every sale, service, marketing, commerce, and IT interaction.

Einstein GPT will infuse CRM’s proprietary AI models with generative AI technology from an ecosystem of partners and real-time data from the Salesforce Data Cloud. The new launch is expected to boost the company’s growth and profitability.

In terms of the trailing-12-month gross profit margin, CRM’s 74.52% is 55.6% higher than the 47.89% industry average. Likewise, its 23.30% trailing-12-month EBITDA margin is 157.8% higher than the industry average of 9.04%. Furthermore, the stock’s 31.95% trailing-12-month levered FCF margin is 355% higher than the industry average of 7.02%.

For the fiscal second quarter ended July 31, 2023, CRM’s total revenues increased 11.4% year-over-year to $8.60 billion. Its net cash provided by operating activities increased 141.9% over the prior-year quarter to $808 million. The company’s non-GAAP net income rose 76% year-over-year to $2.09 billion. In addition, its non-GAAP EPS came in at $2.12, representing an increase of 78.2% year-over-year.

Analysts expect CRM’s EPS and revenue for the quarter ending October 31, 2023, to increase 46.7% and 11.2% year-over-year to $2.05 and $8.72 billion, respectively. It surpassed the Street EPS estimates in each of the trailing four quarters. Over the past nine months, the stock has gained 70.6% to close the last trading session at $222.53.

CRM’s POWR Ratings reflect this positive outlook. CRM has an overall rating of A, which translates to a Strong Buy in our proprietary rating system.

It is ranked #8 in the same industry. It has an A grade for Growth and Sentiment and a B for Quality. To see the other ratings of CRM for Value, Momentum, and Stability, click here.

Stock #1: eGain Corporation (EGAN)

EGAN specializes in developing, licensing, implementing, and supporting customer service infrastructure software solutions. Their main offering is the Knowledge Hub, a unified solution that automates, augments, and orchestrates customer engagement. EGAN provides subscription services for cloud-based access to their software and offers professional services.

In terms of the trailing-12-month levered FCF margin, EGAN's 14.05% is 100.1% higher than the 7.02% industry average. Likewise, its 0.83x trailing-12-month asset turnover ratio is 34.4% higher than the 0.62x industry average. Additionally, its 71.89% trailing-12-month gross profit margin is 50.1% higher than the industry average of 47.89%.

EGAN's total revenue for the fiscal third quarter ended March 31, 2023, came in at $23.01 million. Its non-GAAP gross profit came in at $15.79 million. Its non-GAAP net income came in at $1.08 million. The company’s non-GAAP income from operations came in at $935 thousand. In addition, its non-GAAP EPS came in at $0.03.

Street expects EGAN's EPS and revenue for the quarter ended June 30, 2023, are expected to increase 83.3% and 0.9% year-over-year to $0.06 and $23.71 million, respectively. It surpassed the consensus EPS estimates in each of the trailing four quarters. Over the past month, the stock has declined 16.6% to close the last trading session at $6.24.

EGAN's strong fundamentals are reflected in its POWR Ratings. It has an overall rating of A, which translates to a Strong Buy in our proprietary rating system.

It has an A grade for Value and a B for Stability, Sentiment, and Quality. It is ranked #4 in the Software – Application industry. Click here to see EGAN's ratings for Growth and Momentum.

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ADBE shares were trading at $560.65 per share on Friday afternoon, up $0.19 (+0.03%). Year-to-date, ADBE has gained 66.60%, versus a 17.25% rise in the benchmark S&P 500 index during the same period.

Since he was in grade school, Dipanjan was interested in the stock market. This led to him obtaining a master’s degree in Finance and Accounting. Currently, as an investment analyst and financial journalist, Dipanjan has a strong interest in reading and analyzing emerging trends in financial markets.

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