Ivy Sector Insights – Information Technology (Software)
Commentary as of April 15, 2020
Portfolio managers are thinking about how they adapt their portfolio to the new environment, with greater probability of recession and earnings reductions. There's certainly a chance that things get a lot worse, though there's certainly a chance that we bounce back.
In this environment, we believe software is currently an attractive area. Video games put a large strain on broadband consumption a few weeks ago, with many people staying home and playing games. One of the risks we're seeing is the epicenter being focused on small businesses. There are a number of software businesses that sell into that market, so we're trying to be cautious with some of those companies.
If you look back at time periods where the market was stressed, performance of software has been pretty impressive. The most recent time period for comparison was the 2008-2009 recession. Stocks were down, in some cases, 60% or more. Earnings estimates were revised much lower. Software held up much better than the broader market, and when the market recovered, software continued to perform well.
In a down market, software companies typically protect earnings better than most companies. In a recovery, investors tend to like these types of business models and have the opportunity to buy shares at depressed valuations.
In today’s environment, we're thinking about valuations – what expectations are reflected in prices. Looking at price/sales, median has gone from 8x in January to 5.5x today. However, valuation dispersion has been very wide. It peaked in mid-March and has come down a bit, but there are still big differences between the most expense companies and the peer group median. When valuation dispersion is wide, the most expensive group tends to underperform the average or median company. So, we want to be careful with the companies we're recommending, knowing some are quite expensive relative to alternatives within the group.
One risk to note within software is small businesses. A lot of software companies are focused on providing payroll software, accounting software or payment processing software. Many of these businesses have completely shut down. We're encouraged by the stimulus package, and we'll watch how small businesses are able to weather the current market environment. Our approach is to look at the companies with an understanding there is a wide range of outcomes, and trying to find the businesses that aren't pricing in a perfect recovery, or something that is pricing in a more negative outcome. To summarize, we believe software companies are attractive relative to the market, though we want to be very mindful of valuation within the industry.
Past performance is not a guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through April 15, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
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