By Philip van Doorn
Investors looking for bargains in an expensive stock market might be better off focusing on sales growth as an indicator, based on how well software companies’ stocks have performed.
Jefferies analyst Sean Darby cited two important trends in support of the software industry in a July 19 report: An “unprecedented upswing” in U.S. capital spending by companies and “record U.S. business formation” in a tight labor market. Those trends mean increases in software subscriptions.
At first glance, software stocks as a group appear to be expensive. Here’s a comparison of the movement of forward price-to-earnings ratios (based on rolling 12-month consensus earnings estimates among analysts polled by FactSet) for the S&P 500 software industry group and the full S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.25% over the past five years:
But you get what you pay for. Before looking at sales, earnings and cash flow comparisons, check out how well the S&P 500 software industry group has performed against the full index over the past five years, with dividends reinvested:
The S&P 500 Index has done well. The software industry group is almost literally off the chart.
Looking back and looking ahead
Here’s a comparison of sales growth figures for the S&P 500 software industry group and the full S&P 500 over the past five full calendar years:
|S&P 500 Software||11.3%||11.3%||17.4%||9.6%||-2.8%|
Now let’s look ahead at aggregate sales-growth projections for 2021 and the next two years, based on consensus sales-per-share estimates:
|S&P 500 Software||14.6%||12.8%||9.8%|
Here’s a look at the growth of earnings per share for the S&P 500 software industry group and the full index over the past five years.
|S&P 500 Software||21.9%||102.5%||-21.1%||35.4%||-9.8%|
Here are aggregate EPS estimates for 2021 and the following two years, based on consensus estimates:
|S&P 500 Software||16.8%||12.1%||8.8%|
Free cash flow
A company’s free cash flow is its remaining cash flow after planned capital expenditures. It is money that can be used for business expansion, acquisitions, share buybacks, dividend increases or other corporate purposes.
Here are comparisons of increases in aggregate free cash flow per share for the two groups over the past five years, based on consensus estimates:
|S&P 500 Software||17.9%||14.8%||8.6%||20.1%||12.0%|