Software is a huge sector, and like any huge sector there is a mix of wheat and chaff. The trick, then, is to separate the two and focus one's time on the most promising ideas. The following are five above-average software companies that are worth a closer look by investors seeking some technology ideas with solid chances of market-beating performance.
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1. Cognizant Technology Solutions (Nasdaq:CTSH)
Cognizant is the youngest of the Tier 1 Indian IT firms (which includes Infosys (Nasdaq:INFY) and Wipro (NYSE:WIT)), and has the added twist of a U.S.-based management. Employee turnover is quite high compared to U.S. software companies, but this is nothing new in this sector. The company has a high reliance on financial services, but recently crossed the $1 billion mark in quarterly revenue despite the uncertain conditions in the sector. Wage and tax pressures in India are concerns to monitor, but recent revenue growth in excess of 40% and increasing analyst estimates suggest solid near-term momentum.
2. DST Systems (NYSE:DST)
DST Systems is the outlier in this group, as the stock has underperformed the S&P 500 over the last year and the valuation is quite a bit below the industry average. DST is the largest third-party shareholder record keeping company, and has a significant share of the outsourced mutual fund business. The company also owns stakes in State Street (NYSE:STT), Computershare and Euronet Worldwide (Nasdaq:EEFT) - and those holding are worth about one-third of the stock's current valuation. Even allowing for risk of the company's reliance on healthy equity and credit markets, DST looks like a software name that could appeal to value investors.
3. MICROS Systems (Nasdaq:MCRS)
Investors are starting to feel quite a bit better about the hospitality industry, as the casino, hotel and restaurant sectors have been outperforming recently. As a provider of software and IT products to that sector, it perhaps not so surprising that the stock of MICROS has been strong as well. As the travel and leisure markets improve, MICROS should see good operating leverage here and from international customers. There is likewise the possibility to deepen its penetration in a sector that has not yet consistently adopted technology outside of the large national operators.
4. Oracle (Nasdaq:ORCL)
Oracle has had a good run over the past year (up about 35%), but still does not look overpriced. Assuming that Oracle can continue past success in middleware and applications and take a leadership position in this hardware/software hybrid model that seems to be emerging in the large-cap IT space, the odds should be pretty good that Oracle continues to outperform the market.
5. Red Hat (NYSE:RHT)
Like Cognizant, MICROS and Oracle, Red Hat has enjoyed a good run over the past year. Unlike the other names on this list, however, Red Hat builds itself on the basis of service and support. Much as Microsoft (Nasdaq:MSFT), IBM (NYSE:IBM) and VMWare (NYSE:VMW) want to break that dynamic and convert customers to their proprietary products, there is likely to always be a segment of the market that prefers open-source software over proprietary systems.
On top of that, Red Hat has the opportunity to expand its service model into the growing cloud and virtualization markets, a move that would likely mean above-average returns if successful.
The Bottom Line
Software, and technology in general, can offer volatility and valuation levels that trouble conservative investors. That said, they are often cash-generating high-margin businesses and even a conservative investor may find that a small allocation to software is worth the trouble. These names are just a starting point for due diligence, but each would seem to have a better than fair shot at solid performance in both the short and long term. (For related reading, take a look at 4 Industry Changing Tech Trends.)
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