Analyzing 3 Software Stocks - Buy, Hold, or Sell?

The software industry worldwide is witnessing a remarkable expansion, fueled by escalating demands for digital transformation across diverse industry sectors. The incorporation of generative artificial intelligence within these applications edges toward catalyzing an even more robust escalation across the industry.

Given the industry’s promising outlook, we evaluate three software stocks in this piece to shed light on how they can aid investors in leveraging the ongoing industry trends to their advantage.

A solid buy candidate for 2024 appears to be Dynatrace, Inc. (DT), given its robust fundamentals. Conversely, Datadog, Inc. (DDOG) should be kept on one's watchlist for better entry opportunities, while Confluent, Inc. (CFLT) should be best avoided, given its weak fundamentals.

Let’s first look at what’s shaping the software industry before delving deeper into the fundamentals of the three stocks.

The enduring influence and exponential impact of the software industry continue to shape individuals and institutions worldwide, evidencing its dynamic domino effect. Contributing an estimated $1.4 trillion annually to the U.S. economy, this sector stands as a vigorous pillar of economic advancement and is projected to remain a potent catalyst for growth in the upcoming years. The global software market is expected to reach $1.79 trillion, growing at a CAGR of 11.7% until 2032.

Digital transformation, encompassing artificial intelligence, process automation, and cloud data migration, gains momentum through strategic IT investment and deployment across various sectors. Anticipated growth in IT spending will catalyze digital transformation across a wide range of industries. Gartner's forecast for worldwide IT spending in 2024 anticipates a substantial upswing of 8%, yielding a head-turning $5.1 trillion.

The 2024 Gartner CIO and Technology Executive Survey reveals that CIOs are concentrating their investment efforts on Business Intelligence/data analytics and cloud platforms. A resounding 78% of CIOs demonstrate an interest in increasing spending on BI/data analytics, while 73% express an inclination toward intensified investment in cloud technology.

The business software market is forecasted to grow at an 11.2% CAGR to reach $1.10 trillion by 2029.

Considering these conducive trends, let's take a look at the fundamentals of the three software stocks.

Stock to Buy:

Dynatrace, Inc. (DT)

DT provides a security platform for multicloud environments. It operates Dynatrace, a security platform that provides application and microservices monitoring, runtime application security, infrastructure monitoring, log management and analytics, digital experience monitoring, digital business analytics, and cloud automation. The company also offers implementation, consulting, and training services.

In November, DT achieved the Amazon Web Services (AWS) Security Competency. By earning this competency, DT has demonstrated expertise in helping its customers proactively remediate vulnerabilities and defend against threats across their AWS environments.

This recognition reinforces DT’s position as a trusted AWS partner and is a testament to its AI-powered approach to identifying, blocking, and investigating vulnerabilities in hybrid and multi-cloud environments. It further motivates the company to continue helping customers accelerate cloud migration and transformation with confidence.

DT’s trailing-12-month ROTA of 6.09% is significantly higher than the industry average of 0.48%. Its trailing-12-month net income and levered FCF margins of 13.06% and 24.42% are 453.7% and 182.4% higher than the industry averages of 2.36% and 8.65%, respectively.

For the fiscal second quarter that ended September 30, 2023, DT’s total revenue and non-GAAP gross profit increased 25.9% and 28.3% year-over-year to $351.70 million and $298.74 million, respectively. Moreover, its free cash flow stood at $34.13 million, up 36.1% from the year-ago quarter.

For the same quarter, its non-GAAP net income and non-GAAP net income per share increased 45% and 40.9% from the prior-year quarter to $93.49 million and $0.31, respectively.

Street expects DT’s revenue and EPS for the fiscal third quarter of 2024 (ended December 2023) to increase 20.3% and 11.8% year-over-year to $357.75 million and $0.28, respectively. The company surpassed consensus revenue and EPS estimates in each of the trailing four quarters, which is impressive.

The stock has gained 36.4% over the past nine months to close the last trading session at $56.25. Over the past year, it has gained 53.5%.

DT’s POWR Ratings reflect this promising outlook. The stock has an overall rating of B, equating to a Buy in our proprietary rating system. The POWR Ratings are calculated by considering 118 distinct factors, with each factor weighted to an optimal degree.

DT has a B grade for Growth, Sentiment, and Quality. It is ranked #29 out of 134 stocks in the Software – Application industry.

To see the additional ratings for DT (Value, Momentum, and Stability), click here.

Stock to Hold:

Datadog, Inc. (DDOG)

DDOG operates an observability and security platform for cloud applications in North America and internationally. The company’s products include infrastructure and application performance monitoring, log management, digital experience monitoring, continuous profiler, database monitoring, network monitoring, incident management, observability pipelines, cloud cost management, and universal service monitoring.

On November 27, 2023, DDOG announced expanded security and observability support for AWS serverless applications built on AWS Lambda and Step Functions services. The functionality helps AWS Lambda and Step Functions users detect security threats, get a high-level overview of how their state machine is performing at a single point in time, and monitor services instrumented with OpenTelemetry.

On the same date, DDOG added identity, vulnerability, and app-level findings to the Security Inbox. This provides engineers with one actionable view to improve security posture without any additional overhead or friction.

With these new features, DDOG shifted cloud security earlier in the software development lifecycle and empowered developers and security teams to address issues proactively. DDOG’s Security Inbox delivers a unified view of the top issues DevOps and security teams need to address to reduce risk significantly.

DDOG’s trailing-12-month cash from operations of $554.17 million is 617.2% higher than the industry average of $77.27 million. Its trailing-12-month gross profit and levered FCF margins of 80.01% and 26.18% are 62.8% and 202.7% higher than the industry averages of 49.14% and 8.65%, respectively.

For the fiscal third quarter that ended September 30, 2023, DDOG’s revenue and non-GAAP gross profit increased 25.4% and 29.5% year-over-year to $547.54 million and $450.87 million, respectively. Moreover, its free cash flow stood at $138.19 million, up 105.9% from the year-ago quarter.

For the same quarter, its non-GAAP net income and non-GAAP net income per share increased 95.5% and 95.7% from the prior-year quarter to $158.46 million and $0.45, respectively. As of September 30, 2023, its total current assets stood at $2.82 billion, compared to $2.34 billion as of December 31, 2022.

Street expects DDOG’s revenue and EPS for the fiscal fourth quarter of 2023 (ended December 2023) to increase 21.1% and 67.9% year-over-year to $568.24 million and $0.44, respectively. The company surpassed consensus revenue and EPS estimates in each of the trailing four quarters.

The stock has gained 84% over the past nine months to close the last trading session at $123. Over the past year, it has gained 77.7%.

DDOG’s fundamentals are reflected in its POWR Ratings. The stock has an overall C rating, equating to Neutral in our proprietary rating system.

DDOG has an A grade for Growth and a B for Quality. Within the B-rated Software – Business industry, it is ranked #23 out of 42 stocks.

Click here to see the additional POWR Ratings for DDOG (Value, Momentum, Stability, and Sentiment).

Stock to Sell:

Confluent, Inc. (CFLT)

CFLT operates a data streaming platform in the United States and internationally. The company offers Confluent Cloud, Kafka Connect, ksqlDB, and stream governance. It serves automotive, communication, financial services, gaming, government, insurance, manufacturing, retail and e-commerce, and technology industries.

CFLT’s trailing-12-month asset turnover ratio of 0.31x is 49.3% lower than the industry average of 0.62x, while its trailing-12-month CAPEX/Sales of 0.37% is 84.3% lower than the industry average of 2.37%.

For the fiscal third quarter that ended September 30, 2023, CFLT’s total revenue and non-GAAP operating loss stood at $200.18 million and $10.92 million, respectively. Moreover, its free cash flow came to a negative $13.08 million.

For the same quarter, its non-GAAP net income and non-GAAP net income per share stood at $6.33 million and $0.02, respectively. As of September 30, 2023, CFLT’s total current assets stood at $2.17 billion, compared to $2.20 billion as of December 31, 2022.

Street expects CFLT’s revenue and EPS for the fiscal year of 2023 (ended December 2023) to be $769.09 million and negative $0.01, respectively.

The stock has declined 37.7% over the past six months to close the last trading session at $22.31. Over the past three months, it has declined 27.8%.

CFLT’s bleak fundamentals are reflected in its POWR Ratings. The stock has an overall D rating, equating to Sell in our proprietary rating system.

CFLT has a D grade for Value, Stability, and Quality. Within the Software – Application industry, it is ranked #127.

Beyond what we have highlighted above, to see CFLT’s additional ratings for Growth, Momentum, and Sentiment, click here.

What To Do Next?

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DDOG shares fell $0.54 (-0.44%) in premarket trading Monday. Year-to-date, DDOG has gained 1.33%, versus a 0.29% rise in the benchmark S&P 500 index during the same period.

The stock market dynamics sparked Sristi's interest during her school days, which led her to become a financial journalist. Investing in undervalued stocks with solid long-term growth prospects is her preferred strategy. Having earned a master's degree in Accounting and Finance, Sristi hopes to deepen her investment research experience and better guide investors.

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