Amid a wave of apprehension surrounding the impact of artificial intelligence, software sector equities have experienced a notable downturn. However, analysts from Morgan Stanley contend that this market correction has inadvertently created a favorable environment for investment, with numerous companies now trading at prices considerably below their intrinsic worth.
The current year has witnessed a significant decline in the valuation of software firms, largely due to investor anxieties regarding the transformative power of AI. The iShares Expanded Tech-Software Sector ETF (IGV), a key benchmark for the industry, has seen its value decrease by over 20% since the beginning of the year. This dip has been particularly pronounced among major players such as Intuit, ServiceNow, and Salesforce.
Market participants initiated the year with concerns that the proliferation of AI-native startups would intensify competitive pressures, thereby eroding the profit margins of established companies. Additionally, fears arose that AI tools could lead to a reduction in corporate staffing, consequently impacting seat-based revenue growth. These worries culminated in a pronounced sell-off last week, triggered by the introduction of AI-powered legal tools, an event some have dubbed the “SaaSpocalypse.”
Morgan Stanley analysts characterized the recent market decline as extensive and largely indiscriminate, lacking clear distinctions across diverse business models or fundamental strengths. This broad-based sell-off, they argue, has presented compelling opportunities for investors looking to acquire undervalued assets.
According to Morgan Stanley's assessment, five software companies within their coverage universe could see their values double over the next 12 months. This projection is contingent on the easing of AI-related anxieties and a return to their estimated fair value. Prominent large-cap companies like Intuit and Salesforce are identified with potential upsides of 101% and 109%, respectively, from their recent closing prices. Similarly, mid-cap firms including ServiceTitan, CCC Intelligent Solutions, and Vertex are also anticipated to more than double in value.
Many market observers have viewed the software sector's recent slump with a degree of skepticism. Nvidia CEO Jensen Huang, for instance, described the notion that AI would devastate the industry as illogical during a recent event. Analysts at Jefferies, in a Sunday report, indicated that negative market sentiment had become excessively bearish. They expressed confidence in the ability of agile software providers to not only withstand the disruptive forces of AI but also to strategically leverage these technologies for their own benefit.
Presently, investors are increasingly scrutinizing companies for tangible evidence that AI investments are yielding significant financial returns. Recent earnings reports saw the shares of Microsoft and Amazon impacted by shortfalls in cloud growth, which serves as a proxy for their AI-driven expansion. In contrast, Meta Platforms experienced a surge in its stock price after demonstrating that AI tools enhanced advertising performance across its social media platforms, highlighting the market's demand for demonstrable AI impact.
The software industry faces the ongoing challenge of convincing Wall Street that its AI expenditures are translating into concrete financial results. This demonstration is likely a crucial prerequisite for a sustained recovery in stock prices, as noted by Jefferies. In the interim, the technology stock market is expected to remain volatile, as a pervasive sense of uncertainty continues to overshadow the software sector. Morgan Stanley analysts predict that as AI model capabilities continue their non-linear advancement, volatility stemming from disruption will likely persist as a recurrent feature of the market landscape.