Just the other day, I was pondering the decline in PC sales – down 4.4% in the first quarter, compared to last year, according to market researcher IDC. And I assumed, without doing any research, this meant software was also down.
And I wasn’t alone.
With the long-term decline in PC sales, dating back to at least 2012, many investors and the big-money guys on Wall Street are writing off software, too. On the surface, the logic makes sense: If people are buying fewer computers, they’ll need fewer accounting, sales management, and word-processing packages.
But that’s a superficial analysis. Turns out that increased sales of commercial software more than makes up for the decline in PC-related software.
This is why I always do in-depth research before sharing anything with you. Our seemingly impeccable logic can often lead us in wrong directions.
And the right direction is to stay focused on sectors that consistently generate profits and positive cash flow.
Today, I’m going to talk to you about one of the single best software investments you can make. With it, you’ll start benefiting from the profits of the entire software industry, from the big dogs to the young and growing.
Here’s how you get there …
A recent report by Gartner says the software industry hit $407.3 billion in sales last year. Thus, at a time when many on Wall Street were gloomy about software, sales actually grew nearly 5%. And that more than made up for the roughly 10% decline in PC sales that IDC says the industry suffered in 2013
The sector’s staying power is one of the reasons I’ve always paid so much attention to the software industry. These firms don’t have to invest billions in plant and equipment the way hardware companies do. Plus, the software industry runs on a licensing model, meaning that software firms often “rent” their products rather than selling them outright.
That’s a business strategy that traditionally generates a bigger profit.
The challenge, of course, is identifying the firms that are best positioned to profit from this sector transformation.
Fortunately, there’s another way.
That’s why I believe it’s time to take a good look at SPDR S&P Software & Services (NYSE: XSW). This is an all-encompassing exchange-traded fund (ETF) that gives us a broad play on some very intriguing companies.
XSW invests in firms that are involved in e-commerce, social networking, data processing, Internet software, cloud computing and Big Data. It holds roughly 175 stocks in its portfolio.
That big number and its diversity of holdings are part of what I really like about XSW – software in general, and this ETF in particular, touch a wide swatch of the global tech ecosystem.
Of course, XSW holds the obvious big-cap firms like Microsoft Corp. (NasdaqGS: MSFT), Google Inc. (NasdaqGS: GOOG) and Oracle Corp. (NasdaqGS: ORCL).
However, what makes this a really exciting investment is you get the stability of mega-cap leaders combined with an intriguing mix of smaller, growth-oriented firms. I’m talking about companies like:
- Envestnet Inc. (NYSE: ENV). Founded in 1999, Envestnet is a major tech supplier to the nation’s financial service industry. The company’s software products support more than 32,000 professional advisers and some 2.3 million investor accounts that cover combined assets worth more than $570 billion. With a market cap of roughly $1.5 billion, the stock trades at a pricey 42 times earnings but recently grew quarterly earnings by an astounding 450%.
- Blackbaud Inc. (NasdaqGS: BLKB). This Charleston, S.C.-based company has an unusual niche for a publicly traded software firm. The company caters to nonprofits such as research foundations and universities. The company has 29,000 clients that use its software to manage fundraising, accounting, online marketing, and payment services. With a market cap of $1.6 billion, Blackbaud has operating margins of 11% and a 20% return on equity. It recently grew its quarterly earnings by some 43%.
- Web.com Group Inc. (NasdaqGS: WWWW). Based in Jacksonville, Fla., Web.com is the leader in helping small businesses with Web design and e-commerce services. Counting some 3 million customers, it also sells services related to Web hosting, Web management, search engine optimization, social media, and mobile. It even has a Web-based phone management system. With a market cap of $1.8 billion, WWWW has grown sales 62% annually for the past three years.
- Science Applications International Corp. (NYSE: SAI). This is a company I know well and have followed for years. I have even met with the company’s founder, physicist J. Robert Beyster. The McLean, Va.-based firm is a leading expert in cybersecurity for the commercial and defense markets. SAIC also offers information management solutions that make use of advanced warning sensors, deep computer analytics and electronic records management. With a roughly $2 billion market cap, SAIC has 6% operating margin and a 23% return on equity.
- Cadence Design Systems Inc. (NasdaqGS: CDNS). Cadence is a great double play. The firm is a leader in providing software for the booming semiconductor industry. Founded in 1988, the Silicon Valley firm has granted software licenses to roughly 200 firms and counts seven of the top 10 semiconductor makers as clients. With a market cap of nearly $5 billion, Cadence has operating margins and return on stockholders’ equity of 11.2%. It has a three-year earnings growth rate of 44%.
Trading at $85, XSW is a very cost-effective investment vehicle because it covers the entire global tech ecosystem.
I think the timing for this ETF is particularly good. When tech stocks reversed earlier this year, the younger growth firms in the software industry declined much more than the industry itself, pulling XSW down with it.
But since hitting bottom about a month ago, XSW has regained 8% of its value. And it should do much better in the weeks ahead as we get second-quarter earnings results from the high-margin software industry.
XSW is the kind of foundational play you’ll want to hold for the long haul.
Better yet, you now can pick it up at a discount … and then watch your overall returns – and your net worth – reach new heights.
See you next week.