The software industry has notched up gains of 27.58% over the past year as of April 22, making it the top performer in the information technology sector over the period. The technology sector itself is outperforming the broader market by roughly 10% over the past 12 months, which puts the outstanding bull run of software stocks into perspective.
Players in the industry continue to benefit as consumers and businesses expand their reach into new digital environments, such as cloud computing, artificial intelligence (AI) and demand for complex data analytics. Moreover, a move to increase recurring revenues through subscription to Software-as-a-Service (SaaS) solutions presents significant growth opportunities.
Despite the tailwinds pushing software stocks higher, the industry trades at a hefty premium, with a forward price-to-earnings ratio (P/E ratio) of nearly 45 versus 17.52 for the broad market proxy S&P 500. From a technical perspective, several large-cap names in the space have recently formed topping patterns that, when combined with steep valuations, make the industry a prime target for sector rotation as investors chase value elsewhere.
Let's look at three industry stalwarts that could experience selling pressure in the days and weeks ahead as well as possible trading strategies to profit from their falling share prices.
Intuit Inc. (INTU)
Intuit Inc. (INTU), with a market value of $66.78 billion, provides financial management and compliance software for small businesses, consumers, self-employed people and accounting professionals. Its flagship products include QuickBooks for small-business accounting, TurboTax for preparing personal tax returns and Mint for managing personal finances.
Analysts have remained upbeat on the stock in the first quarter, citing the potential of the accounting software maker's TurboTax Live service, which connects consumers with certified tax experts to help them with their tax returns. Guggenheim Securities analyst Ken Wong believes that TurboTax Live could lift Intuit's Consumer Business segment growth potential from 9% to 11% into the midteens. Much of the positive sentiment appears factored in, with the stock trading at over 50 times earnings. As of April 22, 2019, Intuit shares offer a 0.72% dividend yield and have gained 31.42% year to date (YTD).
A head and shoulders pattern has formed on Intuit's chart over the past six weeks, suggesting that a top may be in place. A bearish divergence between the price and the relative strength index (RSI) also shows the bulls losing momentum. Traders who open a short position below the pattern's neckline should set a profit target near the early October swing high at the $230 level, which may now act as a support area. Place a stop-loss order just above the pattern's right shoulder to protect trading capital.
ANSYS, Inc. (ANSS)
Canonsburg, Pennsylvania-based ANSYS, Inc. (ANSS) develops and sells engineering simulation software. The company's software allows customers to test products by simulating multiple concepts before the manufacturing or design process is complete. ANSYS recently forged a new partnership with Ferrari N.V. (RACE) that improves the aerodynamic performance of Ferrari's elite race cars with ANSYS' industry-leading engineering simulation software.
The Street expects the simulation software specialist to post first quarter earnings per share (EPS) of 91 cents on May 7, which compares to reported EPS of $1.09 for the same quarter last year. ANSYS stock has a market capitalization of $15.65 billion and sports YTD gains of just over 30% as of April 22, 2019. It currently trades at 38.24 times earnings.
The ANSYS share price printed an all-time high at $191 on April 16, taking out the previous all-time high set on Sept. 14, 2018, by 55 cents. However, the price failed to hold that level and has since retreated, indicating a possible bull trap. Despite the price making a new high in recent weeks, the RSI made a lower peak, creating a bearish divergence and hinting at a possible trend reversal to the downside. Short sellers should set a take-profit order at $169, where ANSYS shares may find support from the 200-day simple moving average (SMA) and late July swing low. Be quick to close open positions if the stock makes a new all-time high.
Cadence Design Systems, Inc. (CDNS)
Founded in 1988, Cadence Design Systems, Inc. (CDNS) develops system design enablement solutions used to design whole electronics systems, complex integrated circuits and electronic devices. Analysts expect the company to report first quarter EPS of 49 cents and sales of $569.3 million when the automation design software maker releases its results today – Monday, April 22 – after the closing bell. In the same period last year, Cadence reported EPS of 40 cents with sales of $ $517.3 million.
Although the company has a history of beating earnings expectations, the stock looks expensive with a lofty P/E ratio of 51.5. Cadence shares are currently trading up an impressive 45.75% on the year as of April 22, 2019. Institutions command 94.16% ownership of the company.
A double top has formed on the Cadence chart over April, along with a bearish divergence between price and the RSI indicator. Also, volume has increased as the stock has declined away from its second peak set on April 16, indicating heightened selling activity. Those who enter short should buy to cover at the $54 level – an area where the price may catch a bid from a gap formed after the company topped fourth quarter earnings expectations. Set a stop order above the double top in case the price continues making new highs.