A Seductive Software ETF To Buy On The Dip

Software equities and the related exchange traded funds slipped last week as coronavirus concerns gripped global markets. Funds with light exposure to Microsoft Corporation MSFT were particularly vulnerable last week because that stock remained firm following a stellar earnings report.

What Happened

The SPDR S&P Software & Services ETF XSW fell 1.64% last week, but that decline may prove to be more buying opportunity than cause for alarm. XSW holds 165 stocks on an equal-weight basis and the weighted average market value of $28.9 billion of its holdings is on the smaller side compared to some rival software ETFs.

The $240.1 million XSW follows the S&P Software & Services Select Industry Index, which “seeks to provide exposure to the software and services segment of the S&P TMI, which comprises the following sub-industries: Application Software, Data Processing & Outsourced Services, Home Entertainment Software, IT Consulting & Other Services, and Software Systems,” according to State Street.

Why It's Important

Thanks in large part to the cloud, software stocks could be in for another strong year, assuming the broader technology sector maintains its leadership perch.

“The Software & Services industry has historically delivered stronger and more consistent earnings beats than the broader market, as businesses quicken the pace of transitioning to cloud-based software solutions,” State Street said in a recent note.

Over 52% of XSW's holdings are application software companies, levering the fund to demand for enterprise software, including cloud products. Trading at 2.652 times earnings, XSW reflects the growth opportunities being ascribed to that corner of the software universe.

See Also: Bet On Microsoft Earnings With These ETFs

What's Next

“Per Gartner’s latest IT spending forecast for 2020, enterprise software spending is expected to grow more than 10% in the coming two years, as larger companies increasingly adopt cloud-based software solutions,” according to State Street. “After experiencing margin declines in 2018, software companies enjoyed rebounds in EBITDA margins in 2019 and may continue to see margin expansion going forward, as the cloud platform brings scale and operational efficiencies to help lower costs.”

Another perk of software companies is that particularly smaller firms, including those found in XSW, typically derive the bulk of their revenue on a domestic, providing some level of insulation for investors if trade tensions flare up again at some point in 2020.

XSW is higher by 89% over the past three years, outperforming the largest dedicated cloud ETF by nearly 1,000 basis points over that span.