Software stocks have shown resilience amidst a turbulent market, with notable performance in the wake of large-cap earnings reports.
Bank of America analysts noted that software stocks saw a modest increase of 0.5% last week, outperforming the Nasdaq's decline of 3.5%.
The investment bank explained that communication software, in particular, performed well, rising by 4% driven by a significant 6.9% gain in RingCentral (NYSE:RNG).
Bank of America attributes this to a market rotation into high-quality small and mid-cap stocks. Conversely, design software lagged, with Adobe (NASDAQ:ADBE) falling by 3.3%, which analysts suggest is due to a reversal in the AI trade.
The recent volatility in software and the broader market is attributed to several factors.
These include potential interest rate cuts spurred by softer CPI data, which led to short-covering and renewed interest in previously neglected stocks.
Additionally, BofA says there has been a shift from macroeconomic concerns to company-specific factors, with the AI narrative shifting to a "show me" phase. In this context, ServiceNow (NYSE:NOW) and Adobe are seen as potential early beneficiaries.
Meanwhile, valuation metrics for large-cap software stocks are said to show that the EV/NTM FCF/Growth ratio is now at 1.5x, below the five-year median of 1.7x and down from 1.9x at the start of 2024.
BofA explains that the Rule of 40, which measures growth and profitability, indicates improvement for companies like Adobe, Autodesk (NASDAQ:ADSK), Salesforce (NYSE:CRM), and Zoom (NASDAQ:ZM), while Snowflake (NYSE:SNOW), Bentley Systems, Oracle (NYSE:ORCL), and Workday (NASDAQ:WDAY) showed deterioration on a free cash flow basis.
Looking ahead, Bank of America analysts anticipate continued volatility through the second quarter due to mixed demand drivers. However, they expect a recovery in cloud and enterprise spending to drive performance in the second half of 2024.