In 2011, legendary investor and software engineer Marc Andreessen famously said that “software is eating the world,” meaning that software will bring down entire industries and disrupt incumbent stocks. Over the next decade, his vision played out, and software and tech companies dominated the broader market. In 2022, some of the wind has gone out of this sector as rising inflation and recession fears have made many investors less willing to pay high multiples for these companies’ future cash flows .
But software still eats the world — now at a much more palatable rate. Here are the two dominant software companies you can buy today for 2022 and beyond. Each is trading at significant discounts to 52-week highs, but these major industries look poised to continue growing in the coming years.
Image source: Getty Images.
1. Adobe
At a cost of nearly $200 billion, Adobe (ADBE -0.80%) is definitely a company that eats its fair share of the world. Over the past 10 years, this software juggernaut has given shareholders a return of more than 1,160%. This return would have been higher if not for a 24% drop in the stock price this year, creating an opportunity to buy shares at a discount.
Many of Adobe’s products, such as Acrobat, Illustrator, and Photoshop, have become ubiquitous, and many people interact with them every day. These products are part of the Creative Cloud subscription to Adobe’s Digital Media division. Adobe also has a Digital Experience business focused on digital marketing, which offers services such as audience analytics, content management, and digital commerce tools.
Shares of Adobe have fallen sharply year to date as the company has been lumped in with other tech companies hit by a weak economy. But make no mistake, Adobe is not one of those companies that reached a ridiculous valuation while barely making a profit. Adobe made nearly $5 billion in revenue last year. Adobe boasts an enviable gross margin of 87.5%, which is one of the best in the entire software industry (which is great, because this industry is full of companies that maintain strong gross margins). These stellar gross margins demonstrate that Adobe is a dominant software company that provides solutions that are highly valued by customers, empowering Adobe’s pricing and making it a great long-term addition to any portfolio .
2. Service Now
Speaking of dominant software companies, Service Today (NOW -3.25%) is another good choice. Shares of ServiceNow have followed a similar pattern to Adobe and are down a similar 25% year to date, but the business itself is thriving. Like Adobe, ServiceNow has rewarded its shareholders with incredible returns over the past decade, with a 10-year gain of more than 1,600%.
ServiceNow uses the cloud to help companies streamline and optimize their workflows. This makes them more efficient and helps them reduce costs — even in a recessionary environment where software budgets are shrinking, it’s a service that companies will still need, and may become more valuable. ServiceNow generates impressive gross margins of 77.5% and retains many of its customers — in the second quarter of 2022, ServiceNow reported a 99% renewal rate. This quarter, right in the middle of a difficult operating environment with a lot of economic uncertainty, ServiceNow grew revenue by 29.5% on a constant currency basis and also increased its customer base by 22% . The company counts about 80% of the largest companies in the US as its customers, indicating how well established it has become in large enterprises.
With these large gross margins and importance to its large and profitable enterprise customers, ServiceNow looks like a compelling software stock to add to investor portfolios.
Volatility creates attractive entry points
Looking ahead, the market conditions of 2022 will rock the boat for software stocks, but over time, it looks like it just made some attractive entry points to invest in some of the power players of industry.
Michael Byrne has no position in any of the stocks mentioned. The Motley Fool has positions and recommends Adobe Inc. and ServiceNow, Inc. The Motley Fool recommends the following options: long January 2024 $420 calls on Adobe Inc. and short January 2024 $430 calls on Adobe Inc. The Motley Fool has a disclosure policy.