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  • Software stocks have been hard hit in the bear market.
  • Bargain buys are emerging but tilt toward dividend-paying value stocks, not high-growth, high-valuation ideas.

Over the past year, rampant inflation prompted the Fed to pull the punch bowl, increasing interest rates, slowing economic growth, and lowering valuation multiples because higher risk-free yields negatively impact discounted cash flow models.

The worst-performing stocks have been technology stocks, particularly software stocks, which were shining stars during the COVID-era easy-money period because of rock-bottom rates and work-from-home-related spending on cloud computing solutions.

The devaluing of multiples has caused the iShares Expanded Tech-Software Sector ETF  (IGV)  to fall from nearly $450 to $252. Likewise, the Global X Cloud Computing ETF  (CLOU)  has been cut in half, tumbling from $32 to $16. Those declines are worse than the broader SPDR Technology ETF  (XLK) , which has declined 30%, and far worse than the S&P 500, which is down over 20% from its peak.

The thrashing has shaken many investors, but extrapolating last year’s weakness to every software stock may not be the best bet in 2023. After all, the stock market tends to disappoint the masses, so some software stocks are likely worth buying.

A software stock to buy

Typically, past winners aren’t the best prospects. Instead, it’s stocks that have lagged that start shining more brightly in the back half of bear markets. Those early leaders often continue to rally when the market finds its footing, resulting in significant gains.

For this reason, it’s a good idea to concentrate on stocks performing well rather than those still underperforming.

In “Among These Software Giants, I See a Winner,” Real Money Pro’s Ed Ponsi considers some of the largest software companies in search of a potential winner. He remains sour on Microsoft  (MSFT)  and Salesforce  (CRM)  but thinks Oracle  (ORCL)  is worth owning in portfolios. He writes:

“Oracle beat the major indexes and outperformed most of its peers last year, falling just 6.27%. With tech stocks in general and software in particular on the defensive, Oracle might be the best play in the software sector right now.”

Oracle was a high-flying technology company back in the Internet boom days. Its relational database software allowed users to store and quickly retrieve lots of information, features that became mission-critical in the 1990s with the emergence of the Internet and the widespread adoption of computers.

The company’s success made Oracle’s founder Larry Ellison among the world's wealthiest technology pioneers, up there with Steve Jobs and Bill Gates. However, the Internet bust and a string of expensive acquisitions caused it to lose luster with shareholders. As a result, it wasn’t until 2017 that Oracle’s share price eclipsed its Internet boom peak in 2000.

Oracle’s performance since then has been impressive but not nearly as jaw-dropping as other high-flying software companies, particularly those operating in the cloud. For example, Oracle gained 167% from its COVID-low to its 2021 high, but cloud database software darling MongoDB  (MDB)  rallied 420%.

Recently, Oracle’s demonstrated its steady-eddy revenue stream and dividend payout are features, not bugs. As a result, shares are enjoying a renaissance while former high-flyers like MongoDB and others retreat.

Back to Ponsi:

“Are there any good charts in the software sector? Yes, and it belongs to Oracle Corp. The Austin-based software giant has formed a "cup and handle" pattern. This bullish formation suggests Oracle could challenge its all-time high of $104 in the coming year…Oracle is also trading above its 50-day (blue) and 200-day (red) moving averages, a bullish sign. On Wednesday, the stock closed at its highest level in nearly a year.”

CHART-Street-Smarts-JS-010523

Unlike most software stocks, Oracle is one of the few to have recovered its critical 200-day moving average support. Moreover, while other companies report year-over-year profit declines, Oracle’s earnings per share are expected to be $4.89 in fiscal 2023, barely changing from EPS of $4.90 in fiscal 2022. In fiscal 2024, analysts expect EPS to increase 14% to $5.56.

Furthermore, revenue grew a healthy 18% last quarter compared to the previous year, outpacing other software titans. For perspective, Microsoft’s and Adobe’s  (ADBE)  revenue grew 11% and 10% year-over-year, respectively. Salesforce only posted 14% year-over-year revenue growth last quarter.

Perhaps, that explains why more - not fewer - institutional funds own Oracle as of December (3,101) than in March 2021 (3,071).

A software stock to avoid

Salesforce's stock rallied 5,673% from its Great Financial Crisis low in 2008 to its peak above $300 in 2021 because of the growing use of its customer relationship management software. In the process, CEO/founder Marc Benioff became one of the most recognizable and wealthy faces in software, and Salesforce became one of the most-owned growth stocks in investor portfolios (sounds a little like Ellison's rise to fame, doesn't it?).

Salesforce made a big splash acquiring Slack during the COVID work-from-home surge. Still, unchecked spending, including hiring, has taken a toll on its profit, and valuation priced to perfection has resulted in shares falling sharply during the current bear market.

Ponsi writes:

“Salesforce (CRM) on Wednesday said it would cut 8,000 jobs or about 10% of its workforce. The customer relationship management software company also said it would close some offices in an attempt to boost profitability…In a letter to employees, CEO Marc Benioff explained that customers "are taking a more measured approach to their purchasing decisions." It's counterintuitive, but some investors believe the cuts are a sign that it's time to buy the San Francisco-based software company. Let's go to the charts to find out if that's true.

Right now, Salesforce faces two major hurdles. A bearish trend line (black dotted line) that has been intact since late 2021 has capped the stock for over a year. Salesforce has also failed to close above its 200-day moving average (red) for over a year…There is no way I'd purchase this stock as long as it remains below both of these hurdles. The 200-day moving average is trending lower, a bearish sign.”

Unlike Oracle, Salesforce has yet to halt its slide. While the S&P 500 has gained 6.4% and Oracle has gained 37% since September, Salesforce shares are down 5.7%.

Ponsi’s not alone in saying that Salesforce’s weakness has him avoiding the long side. Real Money’s Stephen Guilfoyle wrote this week:

“Though it has been some time since I have been long this name, I had been long Salesforce for a long time. For me at one time, this was my favorite "cloud king," and I trusted Marc Benioff as someone that I would not bet against. I still would not bet against Benioff, but is it time to bet on Marc? Does this restructuring signal that the time to reinitiate CRM is upon us? I am not yet convinced. CRM remains in a 14-month downtrend. I think I need to see a take and hold of that 50-day line (currently $144) before I can believe enough to purchase equity and set my sights on the 200-day line. My decision is "not yet."

The Smart Play

Rising interest rates and a bear market tend to reward value stocks rather than high flyers, particularly when a recession looms. Oracle has rallied nicely since September, but it’s still relatively inexpensive, particularly for a software stock.

Despite a recent surge in its share price, its forward price-to-earnings ratio is only 15, which is still nicely within the 10 to 22 P/E range seen over the past five years. I’d be inclined to shift to the sidelines if shares reach 20 times earnings ($111ish). I’d also take a loss and live to fight another day if shares declined below 200-DMA support. For now, however, Oracle is one of the few software stocks working, and I’m inclined to stick with it until something changes.

Admittedly, Oracle isn’t immune to the macro struggles facing Salesforce, but there’s less excess froth in it weighing down shares. Its many years of lagging performance mean the owners left in it have strong hands and, thus, are less likely to sell rallies. I can’t say the same for Salesforce, given its epic run since the Great Recession and widespread ownership. It shows up in over 1,000 more funds than Oracle, according to Marketsmith.

Also, while Oracle’s 1.5% yield isn’t fantastic, it’s still better than Salesforce, which doesn’t pay dividends. Oracle should benefit if value-oriented, dividend stocks continue winning favor with investors because interest rates remain high.

Overall, it wouldn’t surprise me if Oracle provides solid returns this year with a better risk-to-reward profile and less volatility than other software stocks, suggesting it's the large-cap software stock worth adding to portfolios. 

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