Software Crash: Is This a Generational Buying Opportunity?

Over the past nine months software stocks have been facing a steep decline. That trend was accelerated last week when Anthropic launched a suite of artificial intelligence (AI) tools catered to the legal and data management sectors.  

Software stocks: Time to buy or sell?

Some commentators believe this is the beginning of the end for software. Just yesterday a Goldman Sachs analyst compared the recent software decline to the start of the newspaper industry decline in the early 2000s. They believe software stocks are declining because the terminal value of these businesses will quickly shorten.

Undoubtedly, through the sell-off, the terminal value of almost all software is being downrated, given that many believe AI will swallow the SaaS industry.

Yet, other investors believe this could be a great buying opportunity. Even Jensen Huang, the CEO of Nvidia, admitted that it is absurd to believe people and companies will no longer use software. The incumbent software solutions could be the most likely place where AI solutions will be best utilized by companies and their customers.

Unfortunately, nobody can predict the future. The market shoots first and asks questions later. Generally, it swings too far one way before it moderates to a more healthy balanced view.

For investors, the smartest thing you can do is be sure you have a diversified portfolio. Many people have been caught by this drawdown. Software-as-a-service business models are so profitable that they demand substantial valuation multiples. Over the past decade, they became substantially overweight positions in many investors portfolios.

If you believe in software, this could be a major buying opportunity

If you believe the latter view (that software will still serve a purpose for years ahead), now could be an attractive time to build new positions in some of the best quality names. Many are trading at attractive valuations with high cash flow yields.

Many institutional investors have simply exited the software space. Until these software companies can prove that: 1. AI is either not hindering their business, or 2. Improving their business (even better), there will likely be an overhang on these stocks.

This will likely take the rest of the year to feel out. As a result, these stocks could be sulking for a while. You will have to be extremely patient and be used to discomfort when buying the sector.

Descartes Systems

One software stock on the top of my radar is Descartes Systems Group (TSX:DSG). This has always been an expensive stock. Even though it is down 46% in the past year, it still trades at a premium. Yet, it is trading at its cheapest valuation since 2017.

The thing that many investors fail to recognize is that Descartes is firstly a network. It operates a global logistics network that connects supply chain participants across the globe. Once a customer is connected to the network, it is very difficult to change out.

Likewise, Descartes is starting to use AI to unlock its considerable vats of data. The global trade environment is increasingly becoming more challenging. If it can use AI to improve shipping insights, it could see even more customers come its way.

Descartes has a cash-rich balance sheet. With valuations coming down considerably, Descartes is likely to be very opportunistic in consolidating other software providers. This could be a case of the rich getting richer and the poor getting poorer. Pick the best quality software stocks (like Descartes) in the pullback, and they could still deliver good returns in the years ahead.

The post Software Crash: Is This a Generational Buying Opportunity? appeared first on The Motley Fool Canada.

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More reading

• 3 Major Red Flags the CRA Is Watching for Every TFSA Holder
• Missed Out on Nvidia? My Best AI Stocks to Buy and Hold
• This Canadian Tech Gem Is Off 48%: Time to Buy and Hold for Years
• Missed Out on Nvidia? My Best AI Stocks to Buy and Hold
• Step Aside, Nvidia: This AI Stock is the Real Deal for Canadians in the Know

Fool contributor Robin Brown has positions in Descartes Systems Group. The Motley Fool recommends Descartes Systems Group, Goldman Sachs Group, and Nvidia. The Motley Fool has a disclosure policy.