Our daily lives revolve around software. Whether at home, work, or play, software is likely to play a vital role in our activities. Due to annual recurring revenues (ARR), profitability, and high product demand, software companies make terrific investments. These three companies should be foundational to any well-diversified portfolio.
1. Microsoft
It is tough to talk about software stocks without mentioning the world's largest software company, Microsoft (MSFT 1.65%). Microsoft towers among most others, with a market cap of over $2.5 trillion and fiscal 2021 revenue of over $168 billion. The company's metrics are also top-notch.
Image source: Getty Images.
Microsoft has grown revenues steadily for many years. Since fiscal 2019, revenues have grown from $125.8 billion to $168.1 billion in fiscal 2021. This amounts to a compound annual growth rate of over 15%. This may not seem very high compared to some growth companies. However, when one considers the immense scale of the company, 15% is truly impressive.
Each of Microsoft's three segments grew revenues and operating income, with cloud revenue being especially impressive at $60.1 billion in fiscal 2021. Margins are also trending upwards, with the operating margin reaching nearly 42% in fiscal 2021. Net margin is also clearing an incredible 38%, as shown below.
MSFT Operating Margin (Annual) data by YCharts
Microsoft is not resting on its laurels. Instead, the company is working to develop software for the metaverse. Microsoft would like to corner the metaverse market for the business world with its Mesh and Teams software. These will allow users to interact in this virtual 3D interface. If Microsoft's success in the cloud is any indication, the company will be highly successful in the metaverse as well.
2. Synopsys
The demand for semiconductors, or "chips," is currently much greater than the supply. Just ask an auto manufacturer or dealership. In 2021, several manufacturers had to strategically pause production as a result of the chip shortage. This excess demand creates an excellent market for Synopsys' (SNPS 2.33%) software. Synopsys doesn't produce the chips -- Synopsys sells software that engineers use to design and test them.
As a result of the excess in demand, Synopsys accelerated its revenue growth in fiscal 2021. The company grew revenues 14% in fiscal 2021 after increasing 10% in fiscal 2020 and 8% in fiscal 2019. This pushed the top line to over $4.2 billion, as shown below.
Data Source: Synopsys. Chart by author.
This growth translates nicely to the bottom line, where diluted earnings-per-share rose from $4.27 in fiscal 2020 to $4.81 in fiscal 2021, a rate of over 12%. The company currently trades at a price-to-sales ratio of just over 11, and the stock is near an all-time high. However, this should not deter investors. Wall Street is bullish on the stock, and the short-interest is less than 1%, indicating that investors do not see it as overvalued.
3. Amazon
Many people may not think of Amazon (AMZN 1.30%) as a software company, but it is. In fact, Amazon makes more in operating income from its cloud computing segment, AWS, than from its eCommerce business. For the first nine months of 2021, AWS produced just 13% of Amazon's total revenue but over 60% of its operating income. Net sales for AWS were $44.4 billion, up 36% over the same nine-month period in 2020. In the third quarter of 2021 alone, net sales for AWS were up 39% over the same period in 2020, showing that growth is accelerating in this segment.
Amazon's eCommerce business is currently experiencing headwinds. In 2021 and continuing to 2022, supply chain bottlenecks added significant costs to the bottom line. The tight labor market also added additional expenses. Because of this, the North America and International segments produced a combined loss in Q3 2021. The stock was uncharacteristically flat in calendar 2021 as a result.
The good news is twofold. First, these headwinds are only temporary and should lessen during 2022. Second, AWS picked up the slack, and overall operating income for the first nine months of 2021 was still up considerably over the same period in 2020. The eCommerce business also posted significant growth in net top-line sales, easily surpassing 2020 figures. Once the headwinds slacken, Amazon will again be running at full throttle with significant upside likely for long-term shareholders.
