Microsoft and Salesforce have created a Wells Fargo Software Stock List

Microsoft and Salesforce have created a Wells Fargo Software Stock List ...

Software firms are on a tear, with the S&P Software & Services Select Industry Index up 25% since June 16, but don't get too excited, according to Wells Fargo analysts.

According to a commentary, the first half of the second-quarter earnings season provided some initial signs of relief for the sector.

Although the rise of software stocks is encouraging, we think this is more a result of valuation being too high, too fast, rather than of the overall business environment improving.

In fact, the majority of software companies we cover still mentioned some degree of [negative] macro impact. The stocks likely face uncertainty ahead, according to the authors.

Picture of a Macro

According to the analysts, the amount of recession-related commentary has significantly increased throughout the first half of the current earnings cycle.

This suggests that the current climate is having an impact on underlying principles for software vendors, including hiring slowdowns.

Analysts warned of a headwind.

Most businesses have reported that end-markets are beginning to notice a shift in spending from where things were six to twelve months ago.

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According to analysts, longer deal cycles, deal slippage, and other execution difficulties have resulted in significantly increased mentions.

The majority of companies acknowledged that these effects are still unfolding, which suggests that we aren't out of the woods just yet in terms of a sustained rise in stock returns.

Not all people are created equal.

Not all software companies are created equal, according to analysts. After the recent stock boom, we see selectivity as critical.

We continue to look for businesses that are capable of leaning towards favorable offsets [such as pricing power] and operating more balanced growth profiles.

According to analysts, businesses with product-driven growth that are earlier in the technology adoption cycles should prosper.

Analysts cited two sets of stocks they like, with that in mind:

Microsoft (MSFT), Salesforce (CRM), and ServiceNow (NOW) are three large-cap platforms that benefit from incumbency and free-cash-flow-based valuation support.

2. Small- and medium-cap growth names benefiting from leaner, product-driven growth profiles or secular winners better protected from macro-based headwinds: ZoomInfo Technologies (ZI), HubSpot (HUBS), Atlassian (TEAM), Five9 (FIVN).

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