The SPDR S&P Software & Services ETF (XSW) booked a stellar second-quarter gain of more than 44%, but that doesn’t mean its upside from here is capped.
XSW seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P Software & Services Select Industry Index, which comprises the following sub-industries: Application Software, Data Processing & Outsourced Services, Home Entertainment Software, IT Consulting & Other Services, and Systems Software.
There are several factors that could propel XSW to more upside in the second half of 2020.
“Remote access, cloud storage, and internet-based solutions were strong secular trends before COVID-19. Today’s more digitally-connected world will require more software to function,” said Matthew Bartolini, Head of SPDR Americas Research, State Street Global Advisors, in a recent note.
Sizing up Software
The equally weighted XSW is an ideal play in today’s environment because many of its holdings have solid balance sheets, something the coronavirus outbreak is forcing investors to pay more attention to.
Important to the XSW thesis is that many components are now trading below their one-year median price-to-earnings rations, which is relevant because the industry was widely viewed as expensive on the way up. Beyond compelling valuations, there are bullish demand factors to consider.
As the coronavirus pandemic is proving, the software is at the center of so much that we do every day.
“As a result, software and service firms may benefit from this seismic shift in corporate and consumer behavior across a variety of dimensions: video conferencing, e-learning, telehealth, project, and document management, closed system social communication tools, cloud technologies, digital payments, and cybersecurity,” said Bartolini.
Surging demand for enterprise software as well as cloud and Internet software applications are among the important fundamental factors expected to buoy the software industry in the years ahead.
“This generation-defining shift is one reason why earnings growth for software firms are expected to grow at 16% per annum over the next three to five years – compared to 10% for the broader market – and not see double-digit declines throughout the rest of 2020 and into 2021,” writes Bartolini. “In fact, as shown below, while the S&P 500 is projected to have negative sales growth over the remaining three quarters of this year, software and services firms are projected to continue to grow their top line each quarter.”
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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.