Many software stocks have been under pressure in recent months, as investors have started to perceive them as vulnerable to emerging artificial intelligence (AI) technology. As highlighted in the “6-Month Price History of the S&P Software and Service Index” chart, software stocks have declined roughly 27% from their September 2025 high.
6-Month Price History of the S&P Software and Service Index
Is This a Buying Opportunity?
Do current stock prices represent an opportunity, or are the market’s concerns about AI justified? Today, we highlight the bull and bear case for software stocks as seen by two well respected managers of growth equities at notable investment firms. Ronald Zibelli is Chief Investment Officer of Growth Equities at Invesco and holds a cautious view on software companies in the current environment. Randy Gwirtzman, Portfolio Manager at Baron Capital, specializing in small cap growth stocks, is excited about particular opportunities in the software industry.
The Bear Case for Software
According to Zibelli, many software companies are vulnerable to disruption from AI-driven competitors. In his four-decade career in money management, he has never been more bearish on software stocks. He believes investors have become accustomed to stellar performance from software stocks over a strong two-decade run, but he notes these companies have matured and growth rates are falling. Meanwhile, AI startups that could offer competing solutions are rapidly scaling. Investors have historically assigned software stocks a high valuation, but Zibelli believes the prudence of that is now in question. The urgency for companies to invest in AI is acute, which may be crowding out spending on traditional software. Companies often have a limited IT budget, and they may be more willing to spend on AI than to upgrade their legacy systems. Strategies managed by Zibelli’s team are likely to be underweight software compared to the benchmark indexes, which is a notable change from prior years.
The Bull Case for Software
Gwirtzman provides an opposing, bullish case on particular software companies. According to Gwirtzman, “the [AI] story is overwhelming the reality.” Among the companies he monitors, he believes valuations are the lowest they have been since 2015. At these reduced valuation levels, private equity buyers are showing interest in buying software companies outright, which may help provide price support to the stocks. Gwirtzman walked us through examples of software companies that serve critical functions that he believes AI cannot replicate. When asked about the potential for declining profit margins, Gwirtzman responded that, for companies that cannot be replaced by AI solutions, the margins are sustainable. This may be important to investors, because the software industry developed a reputation for recurring revenue that required relatively modest costs to generate. In other words, once a product was developed, it could be continually resold with little additional cost. Gwirtzman is focused on identifying the best companies and is not buying software indiscriminately. Rather, he is focusing mainly on companies that are vertically integrated, often serving crucial functions to niche industries, and he is avoiding companies dependent on their number of users, particularly where the number of users could be declining.
Software Valuations in Historical Context
Largely due to their high profit margins, software companies have historically been rewarded by investors with price-to-sales ratios above the overall market. The price-to-sales ratio for many software companies has recently fallen below that of the overall market for the first time in 10 years. For software companies to re-establish a premium valuation, investors may want to see reassurance that profit margins will continue to be robust.
Take-Aways for Investors
If certain mutual funds, exchange-traded funds (ETFs), or separately managed accounts (SMAs) in your portfolio have recently underperformed, it may be due to their software exposure. You may want to investigate their holdings and rationale for their investments. Investors who partner with LPL may benefit from our ongoing monitoring of portfolios. LPL Research offers our own proprietary views on the economy, markets, and sectors that we believe are valuable to investors. We also provide access to outside money managers who are free to represent their own unique views in the portfolios they manage. When outsourcing money management, such as when purchasing a mutual fund, ETF, or SMA, investors delegate daily decisions to experienced professionals actively researching and trading in the markets. Furthermore, when LPL Research provides oversight of its model portfolios, we periodically review the exposures we are getting from various funds, ETFs, and SMAs to review that they are well-balanced and not unduly exposed to a particular investment style or market segment.
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