Growth stocks are struggling as interest rates rise, and among the worst offenders are previously richly valued software equities.
The Invesco Dynamic Software ETF (PSJ) is among the exchange traded funds underscoring weakness among software stocks. PSJ, which tracks the Dynamic Software IntellidexSM Index, is off 14.49% year-to-date, but that slump could turn into a buying opportunity.
That opportunity centers more attractive valuations — something that’s often hard to come by in the broader technology sector and certainly a rarity in the software space.
“As of March 25, the median U.S. technology stock was 6% undervalued, a sharp reversal from a sector that was overvalued by 6% and 14% one and two quarters ago, respectively. Yet, while the high number of undervalued mid- and small-cap stocks lowered the median valuation, on a market-capitalization basis, overvalued large-cap stocks bring the tech sector into fair value territory,” notes Morningstar analyst Brian Colello.
PSJ, which has nearly $270 million in assets under management, holds 30 stocks. Adding to the ETF’s potential utility at a trying time for the technology sector is a unique methodology that focuses on stocks’ price momentum, earnings momentum, quality, management action, and value, according to Invesco.
Regarding value, software stocks may just be offering some of that right now.
“Software remains the most attractive subsector. High-flying growth stocks from 2020 have crashed, and many now trade well below our fair value estimates. Meanwhile, more mature, higher-quality software stocks have also sold off and now provide investors with an attractive margin of safety. Many semiconductor firms are also undervalued, while hardware is fairly valued,” adds Colello.
Whether it’s cloud computing or cybersecurity — the latter of which is getting a lift from Russia’s invasion of Ukraine — or software genres, long-term spending needs highlight significant potential with assets such as PSJ.
“In software, IT departments have been focused on digital transformation, first from the secular shift to cloud computing and software as a service, followed by the coronavirus pandemic and the critical rush to implement remote working tools,” concludes Morningstar’s Colello. “We foresee enterprises using software to modernize all types of business processes, in turn leading to software industry growth at a low-double-digit CAGR.”
The average market capitalization of PSJ’s member firms is $138.6 billion.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.