Software Stocks Are Rallying Again — But Earnings May Not Be the Reason

Software Stocks Are Rallying Again — But Earnings May Not Be the Reason

Falling valuations, rather than weak company performance, may explain both the software sell-off and its recent recovery.

Software stocks are staging a sharp recovery, but improving earnings may have little to do with the move.

The iShares Expanded Tech-Software Sector ETF, commonly tracked through the IGV ticker, peaked at around 117 on 27 October before falling towards 82 by the time US-Israeli strikes were announced. That represents a drawdown of roughly 30% before the conflict became a major explanation for wider market weakness.

Importantly, the underlying businesses were not necessarily deteriorating at the same pace.

Across companies within the IGV basket, median revenue growth was reportedly still around 21% year on year during the sell-off. This suggests investors were not abandoning software because growth had suddenly disappeared.

Instead, valuation appears to have been the bigger concern.

Software shares had traded at relatively high multiples, and investors increasingly became unwilling to pay those prices. Rising geopolitical uncertainty then pushed markets into a more defensive position, putting further pressure on already expensive growth stocks.

That picture has now started to reverse.

As investors become more willing to take risk, capital is moving back towards areas of the market that had previously been heavily sold. Software is one of the clearest examples.

The sector may also be benefiting from comparisons with increasingly expensive artificial intelligence hardware companies and hyperscalers. After months of underperformance, some software businesses now look relatively cheaper, despite continuing to deliver strong revenue growth.

However, investors should be careful about treating the entire software sector as a single recovery trade.

Performance is unlikely to be equal across every company. Businesses with strong recurring revenue, improving margins and reasonable valuations could continue attracting capital, while weaker or excessively valued software shares may struggle.

The rally may therefore be less about suddenly stronger earnings and more about investors deciding that software valuations have finally become attractive again.