By Jacob Sonenshine

It's time to snap up software stocks.

The iShares Expanded Tech-Software Sector exchange-traded fund has dropped 19% to $88 from a record close of $110 in December, as the broader market has sold off on concerns about the economic impact of President Donald Trump's tariffs. Software stocks have been an easy target for investors to book profits: They were especially pricey heading into the latest market rout, as the ETF has more than doubled over the past five years.

Now, software stocks reside in more attractive territory for investors who want to buy up a sector with strong earnings growth.

For starters, the ETF is down to a level where buyers tend to come in to support it. Technical analysis shows that as long as the price stays in the $85-$90 area, the fund should remain on its larger uptrend since October 2023 -- signifying that investors see enough earnings potential to buy at these prices.

Relatively speaking, the software sector is a bit of a bargain now, trading at 31.6 times the next 12 months' expected earnings, down from 40 times at the ETF's December peak. The fund's premium over the S&P 500 has narrowed slightly as well: While its price-to-earnings ratio is still is 55% higher than the index's multiple of 20.3 times, that's down from the five-year average of 64%, according to our calculations of FactSet data. The software industry commands a premium because its sales and earnings growth is expected to outpace that of the S&P 500; as that story continues to play out, these stocks' P/E ratios should stabilize soon.

From there, higher earnings over time should help drive software shares upward.

Analysts expect aggregate sales for the software ETF's companies to rise 12% annually over the next three years, according to FactSet. Their customers are shifting their technology capabilities toward cloud-based programs for data management, security, and business planning -- driving healthy revenue gains for Microsoft, Salesforce, and other software providers.

That should drive slightly higher profit margins, leading analysts to forecast 16% annual earnings growth for the software sector for the coming three years.

Plus, the U.S. software giants are seen as somewhat "defensive" stocks. Their services' artificial-intelligence agents are unlocking greater speed and efficiency for business operations -- helping customers reduce costs and incentivizing them to pay higher prices for the software. That's why companies' software spending tends to rise even faster than the growth of the economy and their other operating expenses.

Even if companies have to tighten their belts on spending in the face of a weakening economy, it isn't a shoo-in that they'd have to slash their tech budgets. Companies must invest in AI and advanced technology to stay competitive in their respective industries.

"High quality tech...are not exposed, directly, to tariffs," writes 22V Research's Dennis DeBusschere, whose screen for such stocks included 11 software names. "We like positioning for this group to outperform durably."

Microsoft, Palo Alto Networks, and Palantir Technologies are among the companies whose stocks have gotten cheaper, but are still expected to see solid earnings growth in coming years.

Another is Oracle. On Monday, the company reported that sales jumped 8% to $14.1 billion in the February quarter from a year earlier, excluding the impact of currency fluctuations. Cloud Infrastructure sales soared 51% to $2.7 billion. That segment encapsulates the company's AI offering, which is growing faster than the company's legacy data storage product.

Oracle is still ramping up its AI, an area with massive potential. The AI market is expected to see hundreds of billions of dollars of spending annually in the next few years globally. Mizuho analyst Siti Panigrahi sees Oracle's sales growth accelerating next year -- especially because the company's guidance doesn't even reflect additional revenue from the Stargate project, which aims to build out AI infrastructure in the U.S. rapidly.

"Oracle's broad portfolio of infrastructure and application products, its multi-cloud strategy through hyperscaler partnerships, and unprecedented AI demand position it well to reaccelerate growth," Panigrahi.

Oracle's profit growth should be robust. In the latest quarter, the company's profit margins rose, sending earnings up by 20%.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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March 14, 2025 02:00 ET (06:00 GMT)

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