CFRA has a positive fundamental outlook for the S&P 500 Application Software sub-industry, as we also have for the S&P 500 Systems Software sub-industry, explains analyst John Freeman in CFRA Research's flagship newsletter, The Outlook.

In an increasingly “cloud world,” the distinction between application and systems software becomes fuzzier and less relevant from an investor’s perspective, as the client-server era's clear demarcations dissolve into an increasingly distributed and functionally federated micro-services architecture.

Not to mention the fact that Microsoft (MSFT) and Oracle (ORCL), which together make up 95% of the S&P 500 System Software sub-industry by market cap, generate less than 50% of their revenue from what would be considered “systems software.”

Now including results from 4Q 2021, trailing-12-month revenue for the S&P 500 Software Industry constituents was $459 billion, +19.9% Y/Y, accelerating from 19.2% growth in 3Q 2021 and 17.5% Y/Y growth in 2Q 2021. Software industry growth has been accelerating since the second half of 2020, as many enterprises delayed projects and cut spending due to the initial uncertainty at the start of the Covid-19 pandemic. We continue to forecast S&P 500 Software Industry revenue for 2022 to grow 16% Y/Y, primarily driven by cloud migration and Covid-19- related digital transformation projects, partially offset by declining revenue from sales of legacy client-server software licenses and maintenance and support, decelerating only modestly to 14% in 2023.

Compared to the S&P 500 Software Industry, the larger overall global software industry, which grew 2.3% Y/Y in 2020 to $571 billion, contains many smaller, niche-oriented, or country-specific vendors that are more dependent on maintenance revenue from legacy client-server apps.

We project the overall global software industry to grow 10.7% in 2021 to $632 billion (IDC's numbers for 2021 are expected to be published later in 2022) and 9.1% in 2022 to $690 billion.

In August 2020, we formalized CFRA’s “Four Key Trends in Enterprise Software,” which we see as crucial to understanding the software industry and distilling investment-relevant insights as they evolve: Cloud Migration, Digital Transformation, The Rise of Meta-software, and Artificial Intelligence (AI). While the lingo has changed, the investment-relevant impact of these trends has been building for over a decade.

The sharp tech sell-off in 2022 has led to a 32% year-to-date drop in the S&P 500 Application Software sub-industry vs. a 16% decline for the overall S&P 500.

Despite the performance of the stocks, we continue to see strong performance in terms of the fundamentals of most of the constituents, though pure cloud-based providers and those that have successfully transitioned at least half of their revenue to cloud subscriptions are positioned much better to take share and thrive in an economic downturn.

Below we list all of the U.S.-based application software sub-industry companies rated 5-STARS:

Atlassian (TEAM)
Autodesk (ADSK)
Cadence Design Systems (CDNS)
Manhattan Associates (MANH)
New Relic (NEWR)
Paycom Software Applications (PAYC)
PTC Inc. (PTC)
Salesforce (CRM)
Synopsis (SNPS)
Unity Software (U)

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