October 2, 2022

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3 Internet Software Stocks to Buy in a Challenging Industry

5 min read

The Zacks Internet Software industry is 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. Robust IT spending on software is a positive factor for industry participants like Splunk SPLK, Paylocity Holding PCTY and Rimini Street RMNI. However, increased geopolitical risks due to the Russia-Ukraine conflict, higher wage inflation, currency fluctuations and pandemic-inducted supply-chain disruptions are hurting the industry’s prospects. Further, despite the fact that risk related to new coronavirus variants remains a concern, the growing demand for solutions supporting hybrid operating environments is noteworthy.

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 revenue. Advertising is also a major source of revenue. 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 have also 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 Opportunities: Additionally, the growing need to secure cloud platforms, amid 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 #186 that places it in the bottom 27% 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 dim 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 47.5% over this period against the S&P 500 Index’s rise of 5.7% and the broader sector’s decline of 10.4%.

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 2.58X compared with the S&P 500’s 4.58X and the sector’s trailing 12-month P/S of 4.45X.

Over the last three years, the industry has traded as high as 6.75X, as low as 2.25X and at the median of 4.88X, as the chart below shows.

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

3 Stocks to Buy Right Now

Rimini Street – Shares of this Zacks Rank #1 (Strong Buy) company have returned 2.3% year to date. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Rimini Street is benefiting from an expanding clientele. The company’s robust portfolio that addresses the needs of various industries is expected to remain strong in the near term. Growing demand for Application Management Services solutions is expected to benefit Rimini Street’s top-line growth in the long run.

The Zacks Consensus Estimate for Rimini Street’s 2022 earnings stands at 58 cents per share, unchanged in the past 30 days.

Price and Consensus: RMNI

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.

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 the upper end of the market is a tailwind. Further, 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 its portfolio is likely to boost client wins in the long haul.

Paylocity’s stock has declined 15.2% year to date. The consensus mark for its fiscal 2022 earnings is pegged at $2.64 per share, unchanged in the past 30 days.

Price and Consensus: PCTY

Splunk – This San Francisco, CA-based company gains from strong execution across its platform, observability and security businesses as organizations partner with it to secure their infrastructure.

Splunk’s software can be deployed in various computing environments, from a single laptop to large distributed data centers. This feature is helping Splunk win customers. The integration with Amazon Web Services security hub to help customers accelerate response to potential threats is a key catalyst.

Splunk’s shares have gained 19% year to date. The Zacks Consensus Estimate for this Zacks Rank #2 company’s fiscal 2023 loss has stayed at 18 cents per share over the past 30 days.

Price and Consensus: SPLK

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Splunk Inc. (SPLK) : Free Stock Analysis Report

Paylocity Holding Corporation (PCTY) : Free Stock Analysis Report

Rimini Street, Inc. (RMNI) : Free Stock Analysis Report

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