Software stocks have been absolutely hated since autumn. Earnings offer a potential reprieve and an opportunity for traders.
The iShares Expanded Tech-Software Sector exchange-traded fund is down 19% from a record high it reached in September. The pain is worst in the small to midsize names, with HubSpot down 42%, for example, and Zscaler Inc. down 30% in the same stretch. Even Microsoft is down 13% from a brief peak in September.
The problem is that the market is worried about long-term growth, especially for the hundreds of smaller firms that provide businesses with niche software products that could face competition from artificial intelligence.
There is certainly reason for concern. Products from companies such as OpenAI and Anthropic could eventually have business applications, which could make any given software company's business obsolete one day down the line.
The silver lining is that this sets up an opportunity to buy some beaten-down software stocks. At least for the near term, their results likely won't reflect lost market share or competitive threats, so earnings growth will probably turn out to be fine.
Larger profits mean these stocks may have nowhere to go but up, especially because they are cheaper now. While the stocks have dropped since September, analysts' estimates of aggregate sales and earnings for the companies in the software ETF are up, according to FactSet.
Now, the fund is trading for a bit less than 24 times the earnings its component companies are expected to produce over the next year, compared with just over 37 times in September. That is only about two points above the S&P 500's 21.9 times, the smallest premium in at least the past decade.
"The low expectations and low relative multiples could make for a good software trade in the first half of this year," writes Trivariate Research's Adam Parker.
Earnings season for software companies could trigger large gains.
Microsoft, which has earned more than expected in all of the past 13 quarters, reports its fourth-quarter 2025 results on Jan. 28. The company is positioned to weather competition, with a slice of OpenAI, a dominant position selling cost-effective AI solutions to companies, and potential 2025 free cash flow of more than $70 billion. Earnings growth could give investors a reason to buy.
Palantir, reporting Feb. 2, is another company to watch. A provider of products that help businesses identify find ways to save money and boost revenue, as well as tools for the military, it has turned in higher profits than expected in nine of the past 10 quarters.
Results from that pair could signal that earnings for the group are growing in line with expectations, or better, potentially lifting both their shares and other software stocks. Salesforce reports at the end of February and Oracle's numbers will land in early March.
The industry as a whole is growing briskly. Analysts expect aggregate sales for companies in the software ETF to increase by 15% a year for the coming two years. That should be enough to bring profit margins higher, sending earnings up 19% annually, FactSet data indicate.
Investors looking to exploit the potential opportunity should buy the ETF rather than one single stock. While the fund's price could get a boost during earnings season, it could also hold up well over the next couple of years.
The fund is heavily weighted toward the larger providers that are less likely to suffer from disruption to their businesses. And while OpenAI and Anthropic's Claude AI model do pose a competitive threat, investors are protected by buying the ETF. If either company does go public, they likely would find a place within the software fund.
After any earnings-driven gains, investors who do own smaller names could sell. Those are the ones most vulnerable to disruption and obsolescence in the long term.
"Pops will be used as liquidity events for a lot of different software names as the tape the last 6 months, conversations haven't indicated anything to the contrary...guilty until proven innocent right now," writes Jefferies trading analyst Jeff Favuzza.
In a nutshell, buy the big software ETF before earnings. Be ready to sell smaller individual names if they rally.
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