The 10 Worst Software Stocks of 2010

It's been a pretty kind year to stock investors, with the S&P showing a 12.8% gain in 2010. Of course, kindness might still feel relative after a decade of negative returns that included the nauseating depths and panic of the financial crisis.

Still, not every stock sees gains when a rising tide lifts all boats. Here's a list of this year's 10 worst performers in the software industry, which ignores companies that have gone bankrupt or sunk below $200 million in market capitalization.

Source: Capital IQ, a division of Standard & Poor's. Only includes companies listed on U.S. exchanges that contain a market capitalization greater than $200 million.

One of the first things to pop out is the concentration of Chinese stocks, especially those centered in the gaming industry. Aside from NetEase.com and Giant Interactive, it's been a rough year for the industry.

That's partially a result of industry factors, but it's also reflective of a difficult year for Chinese stocks in general. While the S&P 500 has gained 12.8%, the Shanghai composite has largely been a mirror image of its American counterpart, slipping 15% on the year. Given the difficult environment for Chinese stocks and Chinese small caps in particular, it's not surprising to see Chinese companies dominating the list of 2010's software underperformers.

Who else is populating the underperformer list? TeleCommunication Systems led the pack of money-losing software investments last year. The company operates in the booming mobile communications field and is seeing sales continuing to grow at extremely high rates. However, its shares sunk earlier this year. Pinpointing the exact reason the stock saw such a steep sell-off is difficult, but TeleCommunication Systems does have a heavy reliance on defense spending, which is an area investors have fled from after military brass announced spending cuts earlier this year.

 Also on the losers list is Adobe. While the company saw the successful launch of its flagship Creative Suite 5 during the year and just posted a record fourth quarter that surpassed the billion-dollar sales mark, its stock remains in the gutter. Part of the reasoning for Adobe's decline is the company's disputes with Apple. Apple has notoriously kept Adobe's Flash off the operating system powering its iPhone and iPad. Also, new Web standards are aligning around standards that will greatly reduce the need for Flash. While Flash doesn't directly contribute a lot of revenue to Adobe, it's a key growth area, and authoring tools for Flash are a key component of other Adobe programs that contribute more profit themselves.

So what's on tap for software in 2011? One interesting area will be what happens to the industry's 800-pound gorilla. Just missing the list this year was Microsoft (Nasdaq: MSFT), which has posted an 8.1% loss in 2010. Not only will the company be judged by the performance of its core Windows and Office programs, but Microsoft's cloud computing offerings will also have a chance to make a splash. The company spent most of the year saying it was "all in" when it came to cloud computing, but its Azure platform and virtualization offerings have their work cut out to catch up with market leaders.

Another interesting subplot will be American gaming companies. We already saw that Chinese companies struggled in 2010, but it's been a rough year for their American counterparts as well. That's because consumers are shifting their dollars away from spending heavily on games that cost $60 apiece and are spending more money on casual gaming experiences such as Zynga's FarmVille. Despite a successful relaunch of its wildly popular Starcraft franchise, Activision Blizzard (Nasdaq: ATVI) needed a late-year rally to market perform. Investors in the company will have to hope that Activision Blizzard can either decouple itself from the drop in spending through its superior gaming franchises, or that consumers will shift their tastes back to higher priced gaming options.

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