Despite the macroeconomic challenges, the software industry continues to grow steadily, thanks to the widespread adoption of cloud-based software applications and the expansion of digital transformation initiatives across various industries.

Considering these factors, it could be wise to buy fundamentally strong software stocks: ZoomInfo Technologies Inc. (ZI), Instructure Holdings, Inc. (INST), and PDF Solutions, Inc. (PDFS).

Before delving deeper into their fundamentals, let’s discuss why the software industry is well-positioned for growth.

The software industry is a major driver of the U.S. economy, with innovations, job creation, and a significant impact. Technological advances, digitalization in various sectors, data-centric strategies, and investments in cloud technology are fuelling its impressive growth. In just two years, it has added over $1.4 trillion to the U.S. GDP, growing at 6.4%.

The growth is set to accelerate with the integration of generative AI into software. A Goldman Sachs report predicts that this integration could boost customer spending on software, potentially adding $150 billion to the current $685 billion global software market.

Gartner forecasts global IT spending to reach $5.1 trillion in 2024, up 8% from 2023. While GenAI won't have a big impact on IT spending in 2023 and 2024, broader AI investments are boosting overall IT spending. This growth is driven by AI, automation, increased cloud spending, and cybersecurity investments. GenAI is expected to make a significant impact on IT budgets from 2025 onward.

Notably, software market revenues are set to hit $659 billion this year, with global revenues expected to grow at a 5.4% CAGR, reaching $858.10 billion by 2028. Investor interest in software stocks is clear, with the iShares Expanded Tech-Software Sector ETF (IGV) showing a 43.7% return over the past year.

Considering these conducive trends, let’s analyze the fundamental aspects of the three Software - Application industry picks, beginning with the third choice.

Stock #3: ZoomInfo Technologies Inc. (ZI)

ZI and its subsidiaries provide a go-to-market intelligence and engagement platform for sales and marketing teams in the United States and internationally. The company's cloud-based platform helps users identify target customers, obtain predictive lead and company scoring, and engage with automated sales tools to track progress through the deal cycle. 

On October 11, ZI announced the expansion of its global business-to-business (B2B) data, covering 321 million professional contacts at 104 million companies. This expansion includes a significant increase in international data, offering access to over 200 million business contacts outside North America, and broadening the reach for sales and marketing teams globally. 

ZI’s VP of Product Management, Sneh Kakileti, said, “With a focus on expanding our offerings in EMEA, we’ve invested significantly over the past two years into enhancing our global company and contact intelligence. GTM teams both in the U.S. and abroad can now close more deals with customers around the world. 

On September 28, ZI announced a generative AI tool within Chorus, its conversation intelligence solution, that automatically drafts follow-up emails after meetings, simplifying post-meeting communication and enhancing team performance. This tool could boost the company’s prospects, especially given the hype surrounding AI.

In terms of the trailing-12-month levered FCF margin, ZI’s 36.03% is 372.6% higher than the 7.62% industry average. Its 11.10% trailing-12-month net income margin is 221.9% higher than the 3.45% industry average. Likewise, the stock’s 20.67% trailing-12-month EBIT margin is 148.3% higher than the 8.32% industry average.

ZI’s revenues for the third quarter that ended September 30, 2023, increased 9.1% year-over-year to $313.80 million. Its adjusted operating income increased 6.6% year-over-year to $126.20 million. Additionally, the company’s adjusted net income and adjusted net income per share came in at $105 million and $0.26, representing increases of 8.5% and 8.3% over the prior-year quarter, respectively. 

Analysts expect ZI’s revenues for the quarter ending December 31, 2023, to increase 2.9% year-over-year to $310.59 million. Its EPS for the fiscal year ending December 31, 2023, is expected to increase 13.5% year-over-year to $1. It surpassed the consensus EPS estimates in each of the trailing four quarters. Over the past month, the stock has declined 23.6% to close the last trading session at $12.53. 

ZI’s strong fundamentals are reflected in its POWR Ratings. It has an overall rating of B, equating to a Buy in our proprietary rating system. The POWR Ratings assess stocks by 118 different factors, each with its own weighting.

It has a B grade for Growth, Value, and Quality. Within the Software - Application industry, it is ranked #39 out of 131 stocks. To see ZI’s Momentum, Stability, and Sentiment ratings, click here.

Stock #2: Instructure Holdings, Inc. (INST)

INST provides cloud-based learning, assessment, development, and engagement systems worldwide. It offers the Canvas Learning Management System (LMS), Canvas Studio (an online video platform), Canvas Catalog (a course catalog and registration system), Canvas Network, Canvas Credentials (a digital badging solution), and Canvas Student Pathways.

On October 30, INST signed a definitive agreement to acquire Parchment, the world's largest academic credentialing platform and network, for $835 million. The transaction is expected to be finalized in the first quarter of 2024. This acquisition aims to expand INST's customer base and tap into growth prospects in the academic credentialing market. 

In terms of the trailing-12-month gross profit margin, INST’s 65.15% is 31.9% higher than the 49.41% industry average. Likewise, its 29.44% trailing-12-month EBITDA margin is 220.8% higher than the 9.18% industry average. Additionally, the stock’s 32.75% trailing-12-month levered FCF margin is 344.7% higher than the 7.36% industry average. 

For the third quarter that ended September 30, 2023, INST’s total revenue increased 10.2% year-over-year to $134.92 million. Its non-GAAP operating income increased 23.5% from the prior-year period to $57.05 million.

For the same quarter, its non-GAAP net income and non-GAAP net income per share rose 21.2% and 19% year-over-year to $35.76 million and $0.25, respectively. Also, its adjusted EBITDA came in at $58.22 million, representing an increase of 22.3% over the prior year quarter. 

For the quarter ending December 31, 2023, INST’s EPS and revenue are expected to increase 13.7% and 7.9% year-over-year to $0.23 and $134.61 million, respectively. The stock has gained 3.8% year-to-date to close the last trading session at $24.33. 

It’s no surprise that INST has an overall rating of B, which translates to a Buy in our proprietary POWR Ratings system.

It has an A grade for Growth and Stability and a B for Sentiment. It is ranked #31 in the same industry. Beyond what we stated above, we also have given INST grades for Value, Momentum, and Quality. Get all the INST ratings here. 

Stock #1: PDF Solutions, Inc. (PDFS)

PDFS provides proprietary software and physical intellectual property products for integrated circuit designs, electrical measurement hardware tools, proven methodologies, and professional services internationally.

On September 5, PDFS announced the launch of a freemium entry point for its Exensio Analytics Platform, offering limited, off-line features for yield and test operations analysis, root cause identification, and reporting.

Peter Szalay, VP Business Development at PDFS, said, “Our launch of the freemium level is targeting both green and brown field customers that are interested in optimizing their SOC backend flow.  This allows our potential customer to access a powerful big data platform for free, and gives them a migration path to grow in the Exensio Analytics Platform.”

On July 10, PDFS announced the acquisition of Lantern Machinery Analytics, Inc., enhancing their analytics platform for electric vehicle battery cell manufacturing vision inspection.

Dr. John Kibarian, President, CEO, and co-founder at PDFS, expressed his pleasure in welcoming Lantern Machinery Analytics and emphasized the importance of AI-powered vision inspection for electric vehicle battery cell manufacturing.

In terms of the trailing-12-month net income margin, PDFS’ 5.57% is 173.7% higher than the 2.03% industry average. Its 4.29% trailing-12-month Return on Common Equity is 322.9% higher than the 1.01% industry average. Likewise, the stock’s 3.12% trailing-12-month Return on Total Assets is considerably higher than the 0.03% industry average.

PDFS’ total revenues for the second quarter ended June 30, 2023, increased 20% year-over-year to $41.60 million. Its non-GAAP gross profit increased 28.9% year-over-year to $30.72 million. Also, its non-GAAP net income and non-GAAP net income per share came in at $7.50 million and $0.19, representing increases of 74.7% and 72.7% year-over-year, respectively.

Street expects PDFS’ revenue for the quarter ended September 30, 2023, to increase 3.2% year-over-year to $41.14 million. Its EPS for the quarter ending March 31, 2023, is expected to increase 7% year-over-year to $0.20. It surpassed the consensus EPS estimates in each of the trailing four quarters. Over the past year, the stock has gained 10.3% to close the last trading session at $26.71. 

PDFS’ positive outlook is reflected in its POWR Ratings. It has an overall rating of B, equating to a Buy in our proprietary rating system.

It has an A grade for Sentiment and a B for Growth. It is ranked #28 in the Software - Application industry. Click here to see PDFS’ Value, Momentum, Stability, and Quality ratings.

What To Do Next?

43 year investment veteran, Steve Reitmeister, has just released his 2024 market outlook along with trading plan and top 11 picks for the year ahead.

2024 Stock Market Outlook >

ZI shares were trading at $12.48 per share on Thursday afternoon, down $0.05 (-0.40%). Year-to-date, ZI has declined -58.55%, versus a 13.69% rise in the benchmark S&P 500 index during the same period.

Abhishek embarked on his professional journey as a financial journalist due to his keen interest in discerning the fundamental factors that influence the future performance of financial instruments.

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