Wall Street is once again excited about software stocks, and for good reason. These businesses tend to be highly profitable and can generate predictable sales and earnings thanks to the shift toward service-based billing.
Many software platforms are becoming more valuable with the advent of artificial intelligence (AI) technology as well. While there's plenty of overhype to be found when discussing the potential for AI, the technological advances in the works do seem likely to boost the returns of a sect group of software stocks over the coming years.
Given this potential, let's look at a couple of top software stocks that are great buy-and-hold candidates at the moment.
1. Adobe
Adobe (ADBE 0.87%) checks a lot of boxes for investors interested in this space. The software giant has a large global installed base that helped it generate $18 billion in sales in 2022, up 15% over the previous year. Its software-as-a-service selling approach is highly efficient, too, allowing Adobe to produce $2 billion of operating cash flow last quarter. That translates into a blazing 38% operating margin for investors keeping track.
Adobe has an excellent shot at using generative AI to great effect throughout its portfolio into 2024 and beyond. The tech is already lifting demand for products like Photoshop and boosting subscriptions overall. Generative AI is making workflows more productive, so it's no surprise management is pouring resources into that growth initiative. "We are unleashing a new era of AI-enhanced creativity around the world," CEO Shantanu Narayen said in a mid-September press release.
The stock isn't especially cheap. Shares are priced at 13 times annual sales today, close to the high for the year. But investors who believe in the long-term growth thesis shouldn't let that premium deter them from owning this high-performing software giant.
2. Palo Alto Networks
Palo Alto Networks (PANW 0.91%) is doing very well in the cybersecurity space. The company boosted revenue at a 20%-plus rate in each of the last five quarters as security demand remains strong from enterprises cutting spending in other areas of their IT budgets.
That success adds heft to the idea that cybersecurity is a relatively recession-resistant niche. It also reflects Palo Alto Networks' valuable competitive advantages. These include its large installed base, AI-fueled next-gen security platforms, and diverse product offerings.
Palo Alto Networks isn't nearly as profitable as more established peers like Microsoft. But the trend is very encouraging on this score. The company achieved positive earnings for the first time last year, and management is determined to continue that trend into 2024 and beyond. In fact, earnings should rise by about 20% this year to modestly outperform sales growth.
As with Adobe, Palo Alto Networks' valuation reflects a lot of investor optimism. If you're risk-averse, you might want to watch the stock for a pullback to perhaps grab shares at a discount. However, a major advantage of having a multiyear investing horizon is that it gives you plenty of time to accumulate market-thumping returns.
In that situation, paying a little more for a stock won't make a huge difference to your overall returns. If you're optimistic about the software space, you'll likely do well by having Palo Alto Networks and Adobe in your portfolio over the next decade or more.
