Key Takeaways
- Software stocks have underperformed compared to AI-focused companies throughout 2025.
- Morningstar analysts suggest software stocks are greatly undervalued, with many still demonstrating solid fundamentals despite recent downturns.
- Analyst Dan Romanoff highlights ServiceNow as a particularly appealing investment opportunity.
The surge of interest in artificial intelligence has led to remarkable gains for numerous tech stocks, with one major exception: software stocks. Many of the top software companies are reporting substantial losses this year, and according to Morningstar’s equity analysts, several may now be undervalued.
The ongoing decline can be attributed to fears that AI may disrupt the software sector. Concerns exist that AI could lower licensing revenues as tasks become easier and more efficient, potentially rendering traditional software applications obsolete. Dan Romanoff, a senior equity research analyst at Morningstar, notes the uncertainty in the market, stating, “There is a lot of concern. No one really knows how this is going to play out.”
In addition to these worries, the software industry’s struggles have been exacerbated by sluggish revenue generation from AI developments, fluctuating interest rate expectations, and a slowdown following the boom experienced during the COVID-19 pandemic. These factors have contributed to a “brutal” selloff that escalated after July, leading to depreciated valuations. Major players like ServiceNow, Salesforce, and Adobe are now trading at discounts of 20% or more from their true value.
Analyzing Software Stock Performance
While most tech stocks have thrived, software stocks have faced headwinds. For instance, Adobe has seen a 35% drop over the past year, and Salesforce is down 27% within the same timeframe. Other companies like HubSpot and Accenture are facing similar declines. However, Microsoft stands out, maintaining a 19% increase due to its early investment in AI and the benefits it has brought to its Azure cloud services.
The Morningstar Global AI & Big Data Consensus Index has enjoyed a considerable uptick of 26.6% over the past year, while the Morningstar Software Index has only increased by an insignificant 2.6%. Both indexes include Microsoft, which continues to invest heavily in AI and has secured its position amongst the leading tech firms.
Challenges Facing Software Stocks
The primary concern for investors revolves around how AI may transform traditional pricing models used by software-as-a-service companies. Many of these companies rely on a seat-based model where clients pay for monthly licenses. If AI enables greater efficiency within businesses, the demand for multiple licenses may decline, reducing revenue for software firms.
Moreover, broader macroeconomic factors, including slowed growth expectations from the Federal Reserve regarding interest rates, have compounded the situation. Software companies typically forecast high growth and rely heavily on future cash flows, making them sensitive to such fluctuations.
Positive Earnings Reports Amid Concerns
Despite ongoing fears, many software companies have reported robust revenue growth and offered optimistic guidance in recent quarters. “Results are generally good across the board,” Romanoff asserts. Yet, the share prices have not responded favorably. For example, Adobe exceeded revenue growth expectations and indicated successful momentum in its AI solutions but still saw further price declines in its stock.
Valuable Investment Opportunities in Software
As the market adjusts to recent declines, software stocks have become increasingly undervalued. The Software Index, as of November 17, shows a price/fair value ratio of 0.89, indicating an 11% discount to estimated fair value. Adobe, HubSpot, and Salesforce are some of the notable companies trading at deep discounts, with Romanoff estimating that the median stock he covers is undervalued by approximately 30%.
Conclusion
In conclusion, while many software stocks are currently grappling with significant challenges, they also present intriguing investment opportunities. With strong fundamentals, sticky revenues, and an evolving market, there remains a possibility for future growth, particularly for companies like ServiceNow and Microsoft. Ultimately, investors willing to look past current volatility may find substantial value in the software sector.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.