The S&P North American Technology Software Index, which tracks 111 software stocks, has fallen 30% from the all-time high it hit in September. The puts the index in bear market territory, and artificial intelligence (AI) is the root cause.
Specifically, investors worry AI tools will reduce demand for existing products. The selling started months ago, but accelerated when Anthropic released Cowork in January, a conversational assistant that can automate workflows in the sales, finance, marketing, and legal departments, among others.
However, many analysts and business leaders believe investors have overreacted, chief among them is Nvidia CEO Jensen Huang. "There's a whole bunch of software companies whose stock prices are under pressure because somehow AI is going to replace them," he said at a recent event. "It is the most illogical thing in the world."
That does not mean the software stocks will rebound anytime soon, but it does cast the current situation as an opportunity for patient investors. Here's why Microsoft (MSFT 0.73%) and ServiceNow (NOW 2.30%) are worth buying.
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Microsoft: 50% upside implied by the median target price
Microsoft enjoys a strong position in enterprise software, particularly in office productivity, enterprise resource planning, business intelligence, and low-code development tools. The company has supercharged its software products with generative AI assistants, which improve productivity by automating work. Paid Microsoft 365 Copilot seats rose 160% in the December quarter, according to CEO Satya Nadella.
Meanwhile, Microsoft Azure continued to gain market share in cloud computing in the December quarter, accounting for 21% of cloud infrastructure and platform services spending, up from 20% in the September quarter. Those share gains were driven by increased compute capacity from data center buildouts and strong demand for Foundry AI services, which let developers build custom AI agents and applications.
Importantly, Azure is the only major public cloud that provides access to the latest large language models from OpenAI, including those that power ChatGPT. Beyond that, Azure is likely to continue winning market share due to its expertise in hybrid cloud computing. Dan Romanoff at Morningstar explains, "Azure has several distinct advantages, including that it offers customers a painless way and move select workloads to the cloud, creating seamless hybrid cloud environments."
Wall Street estimates Microsoft's adjusted earnings will increase at 15% annually through the fiscal year ending in June 2027. That makes the current valuation of 26 times earnings look sensible. With the stock down 26% from its high, now is a good time to buy. Indeed, analysts' median target price of $600 per share implies 50% upside from the current share price of $401.
NASDAQ: MSFT
Key Data Points
ServiceNow: 83% upside implied by the median target price
ServiceNow is a market leader in several software verticals, including IT asset management (optimizes infrastructure spending), IT operations management (optimizes infrastructure performance), and IT service management (optimizes user experience). Dan Romanoff at Morningstar says the company achieved that dominance by providing a way to automate a wide variety of workflows through a superior user interface.
Research firm Gartner recently recognized ServiceNow as a leader in artificial intelligence applications for IT service management. In the report, the analysts said the company "stands out as one the few providers able to demonstrate semiautonomous behavior through its agentic AI. Its AI Agent Studio allows for creation of supervised and autonomous agents with transparent reasoning explanations."
ServiceNow reported encouraging fourth-quarter financial results that beat estimates on the top and bottom lines. Revenue climbed 20% to $3.5 billion, non-GAAP operating margin expanded 1.5 percentage points to 31%, and non-GAAP earnings increased 26% to $0.92 per diluted share. CEO Bill McDermott said, "There is no AI company in the enterprise better positioned for sustainable, profitable revenue growth than ServiceNow."
Wall Street estimates ServiceNow's adjusted earnings will increase 18% over the next year, while compounding at 19% annually through 2027. That makes the current valuation of 29 times earnings look quite reasonable. With the stock down 52% from its record high, now is an good time to buy. Indeed, analysts' median target price of $185 per share implies 83% upside from the current share price of $101.
