Software Analysts See More Volatility in an Uncertain 2020

(Bloomberg) -- High-multiple software stocks have struggled over the past few months as analysts reassess their growth prospects and valuations, and the group could see additional weakness in 2020, creating an environment where more-defensive legacy names are more favored, analysts said on Wednesday.

“There is a greater level of concern that the global economy could enter into a recessionary environment next year,” wrote Gregg Moskowitz, an analyst at Mizuho Securities. As a result, “there may be an increased risk of a rotation to value stocks that could cause multiple compression among higher growth companies.”

Despite a potential risk to stock multiples, the firm expects software demand to remain robust next year, particularly in the sub-sectors of cybersecurity and cloud computing. It added that “barring a significant recession,” many companies would “navigate these issues very well,” and views both Microsoft Corp. and Salesforce.com Inc. as well positioned.

Salesforce was also singled out by Cowen, which named the company as one of its “best ideas” for 2020.

Next year “could prove to be a volatile year for higher multiple stocks given trends we’ve seen over the last few months,” Cowen analyst J. Derrick Wood wrote. In contrast, he said, Salesforce looks like “an attractive defensive growth investment,” given its lower valuation and “positioning around high growth/high value segments of software.”

A basket of high-multiple software stocks tracked by Goldman Sachs fell as much as 2.6% on Wednesday, and the index was on track for its sixth straight decline, its longest streak of declines since October 2018. Even with the recent decline, the index remains up more than 40% in 2019.

See also: Atlassian, FireEye Slip as Raymond James Notes Growth Concerns

Software Analysts See More Volatility in an Uncertain 2020

Among the names falling on Wednesday was Slack Technologies, down over 6%, Coupa Software, off about 4% and Zscaler, which fell 3.5% despite bullish commentary from BofA. Atlassian Corp. sank 5.7%, while Domo Inc. was off 4.2%. Cornerstone OnDemand and HubSpot each fell more than 3%. Separately, Zendesk fell 1.7%, on pace for a fifth straight decline.

UBS analyst Jennifer Swanson Lowe on Wednesday wrote that small- and mid-cap software-as-a-service companies were “working through the bumps,” even as the overall demand environment for software was “healthy” going into the end of the year.

The comments followed a UBS conference, where companies like Zendesk, Hubspot and Domo “highlighted strong secular demand trends, but also scaling challenges,” according to a report. Lowe added that software pertaining to security, cloud computing and automation were among the categories with “strong market momentum.”

A key catalyst for the software sector will come Thursday afternoon, when Adobe Inc. is scheduled to report its fourth-quarter results. In focus is whether the company is able to maintain revenue growth above 20%; Wall Street is currently expecting growth of 21%, according to data compiled by Bloomberg.

“How investors react to Adobe’s earnings and commentary could presage how software companies and their underlying stock prices will behave in 2020,” wrote Richard Davis, an analyst at Canaccord Genuity.

He said the 20% growth threshold “has taken on a near mythical importance,” and suggested that if companies fail to maintain this level, investors may start “changing their tune” on whether they are comfortable with growth that doesn’t come with operating leverage.

©2019 Bloomberg L.P.

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