The S&P 500’s tech stocks have dramatically fallen out of favour with the stock market this year. And the main reason is artificial intelligence (AI).
AI looks like it’s here to stay, but investors don’t know what to make of it. That’s why share prices have been falling – and I’m looking to take advantage.
Disruption
Conflict in the Middle East has caused some investors to take their eye off the AI threat to software. But it hasn’t gone away. There are some main threats.
The first is that businesses will cancel their software subscriptions and move to cheaper AI-powered alternatives. Even if this doesn’t happen, there’s a risk increased competition will make it harder to raise prices. And this makes high valuations hard to justify.
Displacing existing businesses won’t be straightforward. But I think some companies will prove harder to disrupt than others.
The stock market has been treating software companies as largely the same. And that’s where I think opportunities might be starting to emerge.
Resilience
There are a few things investors can do to try and find opportunities right now. One is to look for unusually high barriers to entry. A good example is software that serves regulated industries. In this case, competing involves more than having a better or cheaper product.
Another is by being vertically integrated into hardware. That makes changing provider a more complicated process than just switching software.
Another strategy is to diversify. Uncertainty brings risk and that means investors might be wise to look to limit their exposure to any given name.
Based on this, one name in particular stands out to me and I’ve started buying it for my Stocks and Shares ISA in the last month.
Software opportunity
The stock is Roper Technologies (NASDAQ:ROP). It’s a group of around 30 software businesses that provides diversification across various industries.
Some operate in regulated industries where barriers to entry are high. As an example, Deltek provides approved software for government contractors. Others are protected by hardware. Neptune provides software for water meters, but it also manufactures these, making it more difficult to disrupt.
In general, Roper’s subsidiaries are focused and specific, rather than broad and generic. And I think that makes them more resilient.
Despite this, the stock’s been falling along with the wider industry. As a result, it’s trading at its lowest free cash flow multiple in the last decade.
Time to buy?
Roper’s forecasting $21.30 in earnings per share this year and the stock is trading at $351. That’s a price-to-earnings (P/E) ratio of 16.5.
The thing is, the stock’s clearly risky. The danger is that the rise of AI means things will look fine until they suddenly don’t. There’s not much management can say to reassure the market in this situation. So investors who are thinking of buying need to be brave.
Roper’s valuation is at a 10-year low. And that reflects sentiment towards the company hasn’t been weaker in the last decade.
I think though, this is a business with unique strengths in an industry that’s firmly out of favour. That’s why I’m looking to keep buying.
