Software Stock Selloff: Top 5 Quality Picks for Investors

[00:00:00]It is a crazy day in the stock market.

[00:00:02]We are seeing a significant sell-off among software stocks. PayPal is down over 20% today while being already cheap. Upspot is down 13% into it is down 12%. S&P Global down 10%, Twilio down 10%, Shopify down 10%, Asenture down 10%. You have Salesforce down another 8%, Adobe down another 7 12%.

[00:00:23]Even dividend aristocrats like Roper Technologies are down 6.1%. ADP, Automatic Data Processing, is down 4.3%.

[00:00:31]Another dividend growth stock, Paychecks, is down 4.8%. And you have big tech giants like Microsoft down 2.7%.

[00:00:38]After they sold off nearly 15% last week. In today's video, I'm going to explain why this is happening. And the top five highest quality software companies you can be buying right now in this buying opportunity. Because after all, as Warren Buffett says, you have to be greedy when others are fearful. And there are a lot of real quality businesses that will do quite well in the coming years. So first let's just talk about why these companies are all selling off. A big reason has to do with AI and that comes from two different angles. One the job market and then two the capability of these AI models advancing especially at creating software. So at one side we have potentially more competition than ever from individuals and smaller companies being able to create highly performant software that gets you maybe 80% of the way there very quickly. At the same time, and I think this is the bigger one when it comes to the economics of all of these stocks that I shared today, is the entire software as a service business model. A lot of this is based on the number of employees at the enterprises they're selling to. All of these software socks are seeing slower seat growth. That's true of Salesforce. It's true of Microsoft. And there are significant fears over potential job loss due to AI. That's why over the past year and a half, you've seen Salesforce stock fall 46% from all-time highs.

[00:01:57]Despite the fact the business is doing better than ever and hitting all-time highs on basically every metric, investors are concerned about what the future of software really looks like.

[00:02:08]What is the future business model?

[00:02:10]especially if it ends up transitioning away from this seatbased model. So that kind of sets the table for the context we'll be discussing today. But I do think there's a lot of highquality businesses that will actually end up doing better in AI. They could benefit from it. And it is an opportunity when the market kind of just indiscriminately starts selling off things. They start avoiding entire sectors. So let's roll the intro and get into my top five software stocks to buy in the selloff.

[00:02:43]>> [music] [music] >> The following reflects the opinions of a man who spends far too much time thinking about stocks. Please do your own research before making any investment decisions. Nothing in this video is personal financial advice.

[00:03:18]Continue at your own risk.

[00:03:20]>> My name is Zach. This is Dividend Data, and you should leave a like and subscribe to the channel if you enjoyed the video. Throughout, I will be using the best stock research tool, which is available at dividendata.com. It includes everything I'll be using throughout. That includes the launch of our new tool, Dividend Data for Spreadsheets. This is an early access for paid members. You can access all of our financial data, 30 plus years of history, and you can get it live in your spreadsheets directly. Google Sheets is already available, and we just submitted our version for Microsoft Excel. And if you want to be one of the first people to try this, we have an early access to it where you can lock in 50% off annual membership to dividend.com. That includes both the Google Sheets and Microsoft Excel version and the web terminal that I showed throughout the video. This is the lowest price that will ever be offered once Excel goes live. this sale is going to be over and this cheap of a price will never be offered again. In fact, to get everything that will be included in this tier of the product, that base price will be higher. So, you're locking in a discount on top of a discount. The link is in the description and pin comment of the video. So, the first stock I'm going to discuss today is Microsoft, ticker symbol MSFT. And if you've been watching my content, that's not surprising. I just bought a ton of this last week when it sold off nearly 15% in the week. I had just hit new lows. going to show you can't time the bottom. If you want a full deep dive on Microsoft, go watch my last two videos. In each one, I give my full investment thesis, but I'll briefly touch on it here today. First, I want to bring up this very funny thing I saw on Reddit relating to this Microsoft selloff. Someone posted, "What the hell happened to Microsoft? I thought it was a safe company to invest and forget. I just checked my portfolio, which is mostly boring companies. What the heck happened to Microsoft? Should I get out?

[00:05:05]I like big, boring companies that are reliable and I thought they were the tech version. What happened? And this post right here is a great reminder of how you can make a lot of money in the stock market. These are the people you're competing against. The stock go down. Oh no, bad. I'm selling crowd. In reality, a person that asks this kind of question on Reddit and is not necessarily interested in learning more about stock analysis, they should not be owning individual stocks at all. They should just be dollar cost averaging into market indexes like the S&P 500.

[00:05:37]The replies were kind of funny to this.

[00:05:39]It said, "Saw this post and bought more shares. Wait until the original post sells, then it will go up." If you can't handle stock prices going down, you shouldn't be investing in individual stocks. When you're investing in individual companies, you're making analysis based on those individual businesses. And I'll give you my brief overview of Microsoft and why I think they're actually an opportunity here, a pretty safe bet from AI disruption.

[00:06:01]First off, you have a lot of negative market news all happening at the same time with Microsoft. You have people worried about the software as a service business model. Microsoft does play in that market with Microsoft 365. Although they have a very lowcost affordable bundle of services that are highly utilized. So I think they're much more safe than other peers and we'll talk about that in a second. Then you also have worries over open AI and how a large part of their Azure growth is coming from Open AI. I just did a big post on that in our private Discord server for dividend data.com members. I outline exactly what I think about the OpenAI risk. You can pause it right now and read it if you want or become a paid member, get our research tools and future spreadsheet tools and then you can be a member, chat with us and read insights like this. I actually think Microsoft is very well positioned to benefit from AI. But first, let's just take a look at the financials. Microsoft has been on a clear path of growth and a lot of that's due to their Microsoft cloud business. That's from their cloud-based software as a service, Microsoft 365, and their cloud-based infrastructure, Microsoft Azure, which is a huge giant growth business where AI is a big catalyst. And they're seeing nearly 40% year-over-year revenue growth. As you can see, their earnings per share every quarter continue to grow. They just hit an all-time high in this latest quarter, and that's despite this December quarter being weaker usually than the September one prior.

[00:07:24]Microsoft has seen their revenue per share grow consistently. 5-year compound annual growth rate of 15%. And despite massive capex spending to build out these AI data centers, they're still close to hitting all-time highs in free cash flow before this latest quarter, which every single year is the weakest quarter of Microsoft's free cash flow.

[00:07:41]The two prior quarters were all-time high metrics. They were generating $26 billion of free cash flow despite spending a ton in capital expenditures.

[00:07:52]Microsoft has a great balance sheet.

[00:07:54]They're in a very strong financial position. They have negative net debt.

[00:07:58]So, the company's in great financial health. Analysts are projecting continued high earnings per share growth in the 15 to 20% range every single year. And they're trading about 25 times forward-looking earnings, which for Microsoft is historically low. And depending on what forward-looking estimates you're looking at, that could be as low as 23. And that is one of the lowest historical forward-looking P ratios you have ever seen for Microsoft stock. It rivals that fall 2022 collapse where I first started my Microsoft position and that's why I personally I have been loading up on Microsoft stock.

[00:08:31]I bought a little bit more today. The company is growing their cash from operations. They just hit all-time high over the trailing 12 months of $ 160 billion and their free cash flow is still strong and slowly growing. The reason it's not growing more is because they're investing so heavily into capital expenditures for their AI data center buildout and they just raised that to a new high number of $29.8 billion in the latest quarter. And you can see this significant ramp up when we look at trailing 12 months. It does not look like it's stopping anytime soon.

[00:09:02]But as I go into in my full Microsoft stock analysis videos, this is an investment. It's not an expense. This is an extremely useful way for the company to redeploy capital, get a good return on investment, and make sure they have a lockedin position in AI. And this becomes clear when we dive into Excel and we look at the key performance indicators for Microsoft. So right now we're looking at the quarterly Microsoft cloud revenue. And this has been the huge growth that has propelled the stock up over the past five 67 years that has grown from 12.5 to$13 billion a quarter.

[00:09:36]And in this latest quarter, just like five years later, $51.5 billion. And this growth is not stopping. And we'll take a look at each of the pillars for that. Microsoft 365 and Azure. I'll start with Azure because that's the more clear example. Based on constant currency in the latest quarter, that grew 38% year-over-year. And this is now the largest revenue segment of their largest business, the intelligent cloud.

[00:10:02]And it's growing the fastest. And on the latest earnings call, the Microsoft CFO and CEO said that this could be juiced into the 40% plus growth. And the reason it's not higher is because they're using some of the AI infrastructure for their internal co-pilot and GitHub co-pilot products. So this could be even higher.

[00:10:21]They also reiterated as well as all the big AI companies have reiterated that they are still supply constrained and they need more infrastructure and I think that's going to be the case for a while. So these large capex investments, they're not an expense. They're not wasting money. They're not lighting it on fire. They are reinvesting into something that will lead to high growth in one of their key business segments.

[00:10:43]And over the past 2 years, this growth has accelerated from 30% to nearly 40% year-over-year growth. And back in that 2022 time period, it was around 20%. But then on Microsoft 365, which is the other part of their cloud business, this is where you start to see the similar kind of uh problems that leak into all of these other software as a service companies. Seat growth is slowing, hiring is slowing. A lot of the big tech companies, a lot of the big Fortune 500, they're not necessarily hiring a lot of young knowledge workers, and people are worried about AI disruption. And really, since the pandemic, this was 20% year-over-year growth. That was a big thing in all of SAS. There was huge seed expansion. They thought it would go on forever. This is slowing down though.

[00:11:25]Seed growth is now down to 6% growth year-over-year. So, it's still positive and it stayed six for 3/4 now. But what people I don't think are factoring with Microsoft and I think will be true with a lot of these other SAS companies is the overall revenue growth because the average revenue per user is increasing.

[00:11:43]Microsoft's commercial cloud revenue growth is 14% year-over-year. And this has to do with new products and services that are being added on to this Microsoft 365 bundle. There is a higher tier where you get access to more AI features. So AI is actually a new monetization path for these companies.

[00:11:59]They're making more money per user because they're providing more value per user. And I think this is the undertalked about part of how the software economy will grow. Things are going to move away from seats. It's going to be more based on the value provided to customers. And C-Pilot is really just the start of that. I think the big thing with AI is going to be agents, agentic enterprises, the idea of digital employees that humans work with.

[00:12:23]And over time, you could see fully digital enterprises. And I think Microsoft's in a great position to bring that over into their existing customer base. They serve a lot of the highest value customers, the biggest enterprises. So overall, I think Microsoft is being unfairly grouped into this sector. I think ultimately they'll be a big winner in AI. So let's get through the list. Let's go to stock number two. At stock number two, I have Salesforce, ticker symbol CRM. They sold off another 8% today. They are down 46% from their all-time high of $367. And again, this company's financials are fantastic, and they just hit all-time highs. Analysts are expecting significant growth in the coming years, and it's looking dirt cheap based on the current multiples. Based on the forwardlooking earnings per share projection of $13.16, this is for non-GAAP earnings per share.

[00:13:11]That is a 14.7P ratio. This is unheard of for Salesforce. The company is 67% undervalued based on the consensus price target among Wall Street analysts. And really, it's one of the best enterprise software companies ever. I mean, in terms of making the most money, they're like the example. And their free cash flow is exploding. 5-year compound annual growth rate of 23.78% for free cash flow per share. If we take a look at Salesforce's free cash flow over the trailing 12 months, it's $12.9 billion. The company is now trading at a market cap of $184 billion. That means Salesforce stock is trading at a free cash flow multiple of 14.3. This is dirt cheap for a company with high margin subscription software with a reliable track record of earnings and growth. And this is why I think this whole software selloff is one of the more interesting trends in the market. You have companies like this that if the AI narrative and fears kind of go away, this thing is going to be a huge returner in the stock market. And personally, I think the risk for a company like Salesforce is dramatically overstated. I don't think people really understand how big the product ecosystem is with Salesforce and how much of a moat that creates. The same goes with what I was saying about Microsoft 365, the whole bundle of products and services, how they work together, how they build on each other.

[00:14:32]There's a reason these were some of the best software companies in the world.

[00:14:36]And with Salesforce, they're already starting to see AI integrated throughout their products. As an example, in Slack, you have Slackbot, which just came out, and that's the early innings of a digital employee, a digital co-orker.

[00:14:47]You have agent force which there's an entire new product line focused on customer support through AI agentic use.

[00:14:54]These are net new businesses and I think that's going to be a huge opportunity and I think it's understated how strong of a position companies like Salesforce and Microsoft are in to provide these kind of services. They already have the entire sales apparatus. They're already in. All of these companies are already customers. So, as we head back into the AI analyst on dividend.com and we take a look at Salesforce stock, type in something like CRMP ratio. You scroll down and you can see this chart showing that Salesforce stock is trading at a 15 Ford P ratio. This company is getting dirt cheap. In a similar vein to Salesforce, HubSpot has sold off a ton.

[00:15:33]It basically has hit its lowest price since before the pandemic. Meanwhile, their quarterly earnings per share has gone up five or seven times since then.

[00:15:41]This one is also looking dirt cheap.

[00:15:43]They're basically a smaller version of Salesforce and more focused around the CRM. Salesforce is a little more diversified. They have a larger product ecosystem. But this one's also looking interesting. It didn't make my list though, and that's because I wanted to share examples that were less risky and high quality. As an example, we have into it. That will be my stock number three. Ticker symbol in NU. This company is down 44% over the past 6 months, and they went down 12% today. And again, this is a company with their earnings per share hitting all-time highs on a constant path of growth. What I like about in it is that they do have a diversified portfolio of products. They have Turboax, Credit Karma, QuickBooks, and Mailchimp. I like that they kind of work together. I like that for the most part, they all have deep data for their users, and I think they're kind of sticky, especially QuickBooks and Mailchimp. I would say those are very sticky products. Turboax is interesting because I do think they will see more competitors than ever, but at the same time, they're going to be making it easier and easier for their existing customer base. They're already the number one tax service and all of their customer data from the prior years of filing, it's all there. So, while AI may technically make it easier to create competitors to all these services, the business reality is that they already have a large amount of customers, they have the market presence, their tools will keep getting better as well. So, I think this huge sell-off at into its stock, it's more of a buying opportunity than a risk. The company has a forward-looking PE ratio of 18. Analysts are still expecting double-digit earnings per share growth. Also, all three of the companies I've mentioned today, they are dividend growth stocks.

[00:17:15]Microsoft and into it, they have a long history of dividend increases.

[00:17:19]Salesforce just started their dividend, but that is going to be a dividend growth stock for a while in my opinion.

[00:17:24]In it, their dividend yields now up to 1.12%.

[00:17:28]payout ratios below 30% based on net income and below 20% based on free cash flow. The 5-year compound annual growth rate of the dividend is 15.26%.

[00:17:37]They just had a 15% increase and the payout's very sustainable on a forward-looking basis. This is the cheapest P ratio for in it going back all the way to 2016. So, if you are interested in buying into it stock, now is the best time financially speaking that it's ever been. And as we compare to my first stock that I shared, Microsoft, Microsoft is increasingly becoming a more capital intensive company as they operate tons of infrastructure with their data centers.

[00:18:03]Salesforce and into it, those are clean software businesses. Their capex is next to nothing. So they print free cash flow. As an example, if we look at last fiscal year, they only spent $124 million in capex, $6.2 billion in cash from operations, so over $6 billion in free cash flow. The next stock that I'm going to share today, stock number four, is another pure software company that prints free cash flow. That's Adobe, ticker symbol ADB. They sold off another 7.3% today. They are now down 60% from their 2021 all-time high. That was at $688.

[00:18:41]Adobe is another software giant that's looking dirt cheap now. Now, the risk from AI with this company is that there's going to be a lot more competitors, potentially lowerpriced.

[00:18:51]However, what Adobe has going for it is that they have a massive bundle of products. They also have a huge ecosystem of users and tutorials and guides that have been around for a while in their product categories. They're very dominant both on consumer and in enterprises. The other thing I would say going for them is that artists are pretty anti- AI. So potentially they'll stick around and not want to go to AI native based tools. And Adobe is working on trying to add more AI native features within all of their product suite. And the Adobe Creative Cloud, there's a lot of value in it. The software is pretty good. I pay for it. It's how I edit my videos. You know, do Photoshop for thumbnails and everything. I'm not going to be canceling Adobe anytime soon. But I will admit there has been an onslaught of new products in these categories.

[00:19:37]However, if we look at Adobe's overall business, the growth has been absurd.

[00:19:42]Look at this climb and their quarterly earnings per share. If we take a look at their forward-looking earnings per share, their projected $2344.

[00:19:50]This is non-GAAP EPS for this fiscal year. Based on today's stock price, that's an 11.6 P ratio. 11.6. If we take a look at the financial metrics, this thing has been a rocket ship. 5-year compound annual growth rate of revenue per share, 15.8%.

[00:20:07]Ever since they got that creative cloud with the subscription cloud-based products, this thing has printed money.

[00:20:13]It has been a constant path of growth.

[00:20:15]The company is a free cash flow machine.

[00:20:17]5-year compound annual growth rate of free cash flow preserves 15.9%.

[00:20:21]They just hit all-time highs. Last year, they generated $9.85 billion of free cash flow. If we take a look at their current market cap of $13 billion, that means they are trading at an 11.5 times free cash flow multiple. If you told someone this four or 5 years ago, they would think you're insane. Adobe is a company that used to trade at a 30 to 40p ratio and now they are trading at 12 times forward earnings. So these software stocks are starting to look super cheap. But when I say this, that does not mean that there's no risk.

[00:20:55]There is a reason why some of these stocks are getting cheaper. The entire software as a service business model, it's starting to come under question.

[00:21:03]They don't know how locked in these moes around these businesses are, how defensible the future cash flows are.

[00:21:09]And if we just go back to our investing fundamentals, the entire way that you value businesses is based on the discounted present value of future cash flows. And if you're uncertain about how much and whether or not there even will be future cash flows in some of these businesses, that's why investors are not paying as much for it. And when we were in the pre-AI boom, people were willing to pay a premium for these companies because they did have pretty locked in ecosystems. So the key with investing in these software stocks is finding the ones that you think have the best mo the best product ecosystem, the best network effects, the ones that people will stick with, the ones that can provide more value in the future to customers. That's where the big opportunity is going to be. And I tried to curate a good list with you today. And for stock number five, I'm going to cheat a little bit.

[00:21:58]I'm going to give a couple examples and they're dividend growth stocks that are related to this trend in software. These are divid aristocrats that have raised their dividend for 25 plus years. I'll start with Roper Technologies, ticker symbol RO.

[00:22:12]That stock has sold off 7.63%.

[00:22:15]Current stock price is $344 and it's down 40% over the past year. They just hit all-time highs in quarterly earnings per share. The dividend yield just hit a new high of 1.06%.

[00:22:27]This is normally a very low yield stock because it's a low payout dividend.

[00:22:30]5-year compound annual growth rate of the dividend is 12.17%.

[00:22:34]The most recent demand increase was 10.3%. It's a very sustainable payout, 14% based on free cash flow, 23% based on net income. Next up, I'm going to share Automatic Data Processing, ticker symbol ADP. This is a payroll company.

[00:22:50]Current stock price is $236.

[00:22:53]It's down 4.5% today. And I'm going be honest, I think this one probably could sell off more because in terms of fundamentals, it's a software business.

[00:23:01]It's a payroll company, but then they also have an outsourcing side of the business which I think might be under threat. That said, I don't really know.

[00:23:07]I don't know how it's going to evolve.

[00:23:09]But I do my big theory is that I think over the next 5 to 10 years, we're going to see a lot of digital employees coming in, AI agents that work with you in your enterprise. And really, it it's going to change a lot. So, it's really which companies adapt the best cuz this could be opportunities. If we take a look at ADP, they've adapted over time. They're a dividend king. 50 plus years of dividend increases. This business goes back from before software was even a thing. They transition there. They'll probably transition again. Reliable earnings per share growth. They're still on a track to continued growth. The dividend yields 2.88%. Free cash flow payout ratio is around 50%. The company increases their dividend 10% a year.

[00:23:52]5-year keer 12.82%. Most recent increase was 10.3%. Payout ratio sustainable.

[00:23:58]Overall, I'd take a look at this software sell-off and look at his opportunity. Start doing your research of which companies you think have the most defensible business models that can build and adapt with AI, provide new opportunities. dive in, do your research into these companies because some of these are getting dirt cheap and some of them will probably end up being winners in the AI world. In that case, the stock market returns are going to be fantastic for those companies. So, if you enjoyed the video, make sure to leave a like, comment, and subscribe to the channel.

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