By Sam Stovall
Application-software stocks have been outperforming many other information-technology groups this year as investors anticipate a rebound in IT spending. Year-to-date through Mar. 28, application-software stocks are flat, vs. a 6.5% decline for the IT industry. The group is new to the list of those with top Standard & Poor's .
Jonathan Rudy, who follows application-software stocks for Standard & Poor's, has a positive investment outlook for the group, as earnings appear to be stabilizing while the global economy begins to recover. Earnings have suffered from the slowdown in IT spending after the sharp increase in 2000. IT spending bottomed in the fall of 2001, after the September 11 terrorist attacks, as business declined dramatically for many application-software providers during the second half of 2001. Companies have essentially limited their IT budgets to only the most mission-critical activities.
However, spending should accelerate as companies begin to spend on nondiscretionary items. Specific areas of application software, such as Internet security and customer relationship management (CRM), should benefit more than other areas as outlays recover.
A few positive trends should help boost earnings for the group. Over the long term, many companies continue to use application software to leverage their previous IT investments. In addition, the rapidly evolving Internet, as well as intranets and extranets, are creating strong demand for software that takes advantage of this platform. Many software vendors are integrating Web features into their products, and some are developing new Internet applications, including those related to the booming e-commerce market. Two examples of recent releases of Web-based platforms are Peoplesoft 8, and Siebel 7.
One area that should continue to gain strength this year is entertainment software. Companies such as Electronic Arts (ERTS ) are benefiting from the popularity of three new hardware consoles in the gaming industry: Nintendo's GameCube, Sony's PlayStation 2, and Microsoft's XBox. As each of these platforms continues to develop its installed base, software makers should be able to capitalize on the growth in entertainment software.
Application-software stocks that currently have a 5-STAR (buy) recommendation include Electronic Arts, Siebel Systems (SEBL ), Citrix Systems (CTXS ), and Intuit (INTU ).
S&P Relative Strength Rankings
These industries carry six-month relative strength rankings of "5" as of Mar. 28, 2002 -- meaning that they're in the top 10% of the 115 industries in the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600) based on prior six-month price performance.
*S&P's ranking system for the appreciation potential of stocks over a 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell).
Stovall is chief sector strategist for Standard & Poor's