BMO favors CRM, NOW over IBM in software sector

On Monday, BMO Capital Markets expressed a preference for software companies like Salesforce (NYSE:CRM), ServiceNow (NYSE:NOW), and Dynatrace (NYSE:DT) over services firms such as IBM (NYSE:IBM) and Accenture (NYSE:ACN). This aligns with broader industry trends, as exemplified by SAP’s strong performance with a 54.7% return over the past year and robust revenue growth of 10.5%. InvestingPro data shows SAP maintains a healthy gross profit margin of 73.6%, highlighting the attractive economics of software businesses. The firm’s analyst Keith Bachman highlighted that, although software stocks should command premium multiples compared to services stocks, the market has traditionally valued services companies higher based on enterprise value to free cash flow (EV/FCF) relative to revenue growth. For deeper insights into software company valuations and comprehensive analysis of over 1,400 stocks, including detailed Pro Research Reports, consider subscribing to InvestingPro.

Bachman updated BMO’s sum-of-the-parts (SOTP) valuation for IBM, considering various scenarios and assigning EV/FCF multiples to IBM’s different business segments. He emphasized that IBM’s software business is the most significant driver of the company’s weighted multiple due to its high proportion of EBIT. Despite improvements in IBM’s software offerings through mergers and acquisitions and increased R&D, including the WatsonX solutions, Bachman remains cautious about the long-term revenue impact.

Regarding consulting, Bachman noted that IBM, while a leader alongside Accenture, has historically grown at a slower pace than its competitor and faces challenges from economic cycles and potential deflationary impacts of generative AI. For infrastructure, he maintained that IBM’s mainframe business is cyclical and likely to pose a long-term drag on growth despite short-term benefits from positive mainframe cycles.

In conclusion, Bachman stated that while IBM might be valued higher than Accenture, neither company presents a compelling risk/return profile. Instead, BMO Capital Markets recommends looking to software names like CRM, NOW, and DT for investment opportunities. This view is supported by industry metrics, as leading software companies like SAP demonstrate strong financial health with an Altman Z-Score of 10.24 and maintain consistent dividend payments. To access comprehensive valuation metrics and discover potentially undervalued software stocks, visit InvestingPro’s Most Undervalued Stocks list.

In other recent news, SAP SE (ETR:SAPG) reported its first-quarter financial results, revealing non-IFRS earnings per share of €1.44, surpassing the consensus estimate of €1.32. The company’s operating profit reached €2.46 billion, exceeding the anticipated €2.25 billion, while total revenue was €9.01 billion, slightly below the consensus estimate of €9.07 billion but marking an 11% year-over-year increase when adjusted for constant currency. SAP’s cloud segment grew by 26% in constant currency, and the cloud backlog showed a robust 29% growth, maintaining the same pace as the previous quarter. Analyst firms responded to these results with adjustments to SAP’s stock price targets. TD Cowen raised its price target to $320, maintaining a Buy rating, and BMO Capital increased its target to €320, keeping an Outperform rating. KeyBanc reiterated an Overweight rating with a price target of EUR290, while JMP reaffirmed a Market Outperform rating with a $330 target. These analyst updates reflect a positive view of SAP’s financial performance and strategic direction amidst economic uncertainties.

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