books about online stock trading, forex, futures, stock investing, market, trading systems
What's Not to Like about Software?
Back to contents page

The software industry is highly cyclical, with sales hinging on economic conditions and IT spending. The problem is that in good times software companies thrive, and in bad times they're some of the hardest hit.

The primary reason for this cyclicality is that many corporations view software as a discretionary purchase that can be deferred in tough times. In other words, when the economy and business suffer, cutting IT spending is a quick way to buffer profit declines.

Software companies that cater to corporations have back-end loaded quarters in which the majority of deals are closed in the final days of the reporting period.

This makes it difficult to monitor how business is performing until the quarter has ended, "which increases the risk of a big disappointment. In addition, buyers know that if they wait until near the end of the quarter, a software salesman is likely to slash prices to get a deal done and meet the company's sales quota. But heavy discounting can hurt profitability

Finally, software companies are rarely cheap. The average price-to-earnings ratio of the three largest software companies by market capitalization— Microsoft, Oracle, and SAP—was 56 between 1998 and 2OO2.

This compares to an average price-to-earnings ratio of the S&P JOO of 25 times during that time span. Investors often bid up software stocks because of their excellent growth prospects, high returns on invested capital, and tons of cash flow.

But even compared with other IT-related industries, such as hardware, software firms are typically rewarded with premium valuations because most have clean balance sheets with tons of cash and virtually no debt. Software companies have impressive financial characteristics, including excellent growth prospects, high returns on invested capital, and pristine financial health. The improvements that software provides—increasing revenues, cutting costs, improved productivity—should outweigh any temporary lull in IT spending. But investors will most likely experience disappointing returns by investing in the industry blindly. Our advice is to pick stocks with eco­nomic moats that create barriers to entry, as well as ones that trade at dis­counts to intrinsic value. Don't get seduced by great technology alone.

Smarter trading The art of day trading Trading Chaos Sane Investing In An Insane World
Beat The Odds In Forex Trading