Software is eating the world, and virtually no business is left untouched by it. Companies bringing it to life have been rewarded with explosive earnings growth, and the upward trend shows no signs of stopping as the industry has posted a 44.6% gain over the past six months, beating the S&P 500 by 32.9 percentage points.
However, only a handful of companies will ultimately thrive over the long term as the low barriers to entry for software businesses lead to fierce competition. Keeping that in mind, here is one software stock poised to generate sustainable market-beating returns and two we would avoid.
Two Software Stocks to Sell:
Twilio (TWLO)
Market Cap: $34.4 billion
Known for the clever "Twilio Magic" demo that had developers creating functioning communications apps in minutes, Twilio (NYSE:TWLO) provides a platform that enables businesses to communicate with their customers through voice, messaging, email, and other digital channels.
Why Does TWLO Give Us Pause?
- Sales trends were unexciting over the last two years as its 14.7% annual growth was below the typical software company
- Bad unit economics and steep infrastructure costs are reflected in its gross margin of 48.6%, one of the worst among software companies
- Operating margin expanded by 3.7 percentage points over the last year as it scaled and became more efficient
Twilio is trading at $231.91 per share, or 5.7x forward price-to-sales. To fully understand why you should be careful with TWLO, check out our full research report (it’s free).
Doximity (DOCS)
Market Cap: $4.41 billion
With over 80% of U.S. physicians as members of its digital community, Doximity (NYSE:DOCS) operates a digital platform that enables physicians and other healthcare professionals to collaborate, stay current with medical news, manage their careers, and conduct virtual patient visits.
Why Are We Wary of DOCS?
- Products, pricing, or go-to-market strategy may need some adjustments as its 7.9% average billings growth over the last year was weak
- Estimated sales growth of 4.6% for the next 12 months implies demand will slow from its two-year trend
- Expenses have increased as a percentage of revenue over the last year as its operating margin fell by 10.5 percentage points
At $25.04 per share, Doximity trades at 6.9x forward price-to-sales. Check out our free in-depth research report to learn more about why DOCS doesn’t pass our bar.
One Software Stock to Buy:
Zscaler (ZS)
Market Cap: $27.24 billion
Pioneering the "zero trust" approach that has fundamentally changed enterprise network security, Zscaler (NASDAQ:ZS) provides a cloud-based security platform that connects users, devices, and applications securely without traditional network-based security hardware.
Why Is ZS a Top Pick?
- ARR growth averaged 24.4% over the last year, showing customers are willing to take multi-year bets on its software
- Fast payback periods on sales and marketing expenses allow the company to invest heavily and onboard many customers concurrently
- Robust free cash flow margin of 28.1% gives it many options for capital deployment
Zscaler’s stock price of $176.50 implies a valuation ratio of 7.2x forward price-to-sales. Is now the time to initiate a position? Find out in our full research report, it’s free.
High-Quality Stocks for All Market Conditions
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