Software companies sit in a unique position within the business world. Their products provide vital functions like cybersecurity, design tools, or base functionality for manufacturing. Without them, many businesses wouldn't exist or would be inept. This makes many companies vital to operations, so replacing them isn't easy, which makes them highly resistant to turnover.
This is an excellent quality to look for in a potential investment, and by spreading out which software companies you buy across multiple industries, you can create a diverse portfolio just through software companies. Three of my favorites are CrowdStrike (CRWD 2.03%), Autodesk (ADSK 0.71%), and Adobe (ADBE 0.87%). This trio has been a long-term success story, but I also think right now could be an opportune time to buy all three.
The industries this trio operates in are quite diverse
CrowdStrike is a cybersecurity company specializing in protecting network endpoints (like a laptop or phone). It also has a host of other products to create a more complete cybersecurity platform, but all are centered around one thing: artificial intelligence (AI). CrowdStrike uses a branch of AI known as machine learning to constantly train its models to protect users with the most up-to-date information.
Adobe is more well-known than CrowdStrike due to its prevalence in more common industries. Its graphic design and image editing software suite is utilized in nearly every education level in the U.S., making it the go-to product in the industry. Additionally, Adobe has been developing its Firefly AI assistant to help its users easily create and modify images. This will be a game-changer in the industry and will firmly cement Adobe's place on top of the competition.
Autodesk's products are similarly prevalent within the manufacturing and construction industries. Engineers and architects utilize Autodesk's products daily to bring their ideas to life. Without Autodesk, buildings and products would have to be designed and constructed using hand-drawn prints, a practice that isn't likely to return.
With these three operating in cybersecurity, graphics design, construction, and manufacturing, their paths don't cross. This makes me less concerned about over-concentration, even though they are all software companies.
In addition to their stickiness, software companies also have other benefits to investing in them.
Software companies have superior margins
Because these companies aren't producing a physical product, their gross margins tend to be tremendous because their incremental costs are quite low. With a higher gross margin comes a greater potential for higher profit margins, which Adobe and Autodesk have displayed. (CrowdStrike is a young company still working toward being consistently profitable.)
CRWD Gross Profit Margin data by YCharts.
Investing in businesses with high profit margins is lucrative, as a slight fluctuation in business doesn't send the company into unprofitability. Additionally, these companies can engage in massive stock buyback programs due to excess cash flows once their product lines are complete and only small innovations are necessary. Adobe is in this phase, and has become a model for what nearly all software companies aspire to be.
On the flip side of having high margins, software companies are also usually valued at a premium. This is due to their ability to produce massive profits and stay consistent over time. Those are two things the market values highly, and their valuations reflect that.
CRWD PS Ratio data by YCharts.
But all three of these stocks are much cheaper than they were just a few years ago. Combine that with an economic turnaround, and these stocks could be slated to move higher.
Either way, the long-term outlook of this trio is positive, and I'm confident all will beat the market over the long haul (at least three to five years).
