By Jacob Sonenshine

Software spending should keep growing, even with all the uncertainty about the economy. Still, software companies that can handle a slowdown are the best choices.

And to be sure, the economy is facing serious risk. Even if recession isn't a shoo-in, growth will most certainly slow with import tariffs in the mix. They raise prices and reduce consumer demand. Businesses have lost confidence, which could delay at least some investments in new software.

Growth in overall software budgets is already being pared back, according to a survey by Morgan Stanley's software analysts, headed by Keith Weiss. In February, chief information officers surveyed by Morgan Stanley planned to increase their budgets by 4.4% year over year. By March, the number had dropped to 3.2%.

That's why anyone who wants to buy the dip in software stocks should proceed with caution. Cross off ones that are trading too expensively, which makes them prone to a fall on sales and profit disappointments.

Steer clear of companies that sell a lot to customers in retail, manufacturing and financials services. Those sectors, Weiss writes, probably will pull back the most on spending. Their own demand tends to get hit hard when the economy suffers.

Other companies to avoid are those that sell through a consumption model. In other words, their customers pay as they consume more software. They pay less when they use less software, which happens when their own demand is down. Examples are Snowflake and Datadog.

So the names to play are certain ones that sell cloud-based services, which customers are still adopting. Cloud spending is still growing by double digits.

Cybersecurity sellers Palo Alto Networks and Fortinet are examples. First, their many customers include healthcare companies, which generally have fairly stable demand and probably won't reduce their software spending.Second, Palo Alto and Fortinet sell on a subscription basis -- not consumption, providing more consistent revenue.

They are two of the most dominant cybersecurity providers, with a combined market capitalization of just over $185 billion. They compete against each other, and one's success could mean the other's failure, so betting on both is safer. Total cybersecurity spending is forecast to grow 15% this year, according to Gartner, so betting on the broader space is a sound idea.

Sales growth -- should it spur profit growth -- would lift the stocks.

Palo Alto trades at just over 48 times analyst's expected earnings for the coming 12 months. That's about 50% higher than the iShares Expanded Tech-Software Sector Exchange-Traded Fund's 32 times, but the stock has often traded at almost double the software fund's multiple in the past few years. The lower multiple now is partly because growth is slowing down, but it's still brisk. At some valuation, the stock will be a buy.

Fortinet trades at 38 times earnings, a slimmer premium to the software group versus when it hit 44 times earlier this year.

A third stock to consider is the $170 billion Intuit. The majority of its $19.3 billion in sales that analysts expect this year is subscription.

Intuit is finding millions of new customers each year -- small and large businesses -- to sell bookkeeping, fee-collecting, and marketing software to. The larger customers pay higher prices, another factor driving revenue growth that analysts expect to be 12% annually for the coming three years. The 2027 total is forecast at $24.3 billion.

The kicker is that Intuit's profit margins will probably increase. Its ability to boost sales doesn't need a rapid increase in marketing and other expenses, which is helping drive analysts' expectation that earnings will grow in the midteens.

This growth can take the stock higher since it trade at only 29 times earnings. Historically, it often trades in line with or higher than the software group.

For anyone ready to dip their toes in software or ready to wade in deeper, these are three decent plays.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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April 02, 2025 14:19 ET (18:19 GMT)

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