3 Software Stocks with Warning Signs

Software is rapidly reducing operating expenses for businesses. This secular theme makes SaaS companies attractive investment candidates but also comes with higher valuations that cause volatility. Unfortunately, the rich prices have haunted them over the past six months as the industry has shed 4.9%. This drawdown is a noticeable divergence from the S&P 500’s 6.4% return.

A cautious approach is imperative when dabbling in these businesses as their valuations could plummet if AI disrupts their earnings potential. With that said, here are three software stocks we’re passing on.

Paylocity (PCTY)

Market Cap: $9.82 billion

Operating in a field where companies traditionally juggled multiple disconnected systems, Paylocity (NASDAQ:PCTY) provides cloud-based human capital management and payroll software solutions that help businesses manage their workforce and HR processes.

Why Are We Cautious About PCTY?

1. Estimated sales growth of 7.6% for the next 12 months implies demand will slow from its three-year trend
2. High servicing costs result in a relatively inferior gross margin of 68.9% that must be offset through increased usage

Paylocity is trading at $178.02 per share, or 5.8x forward price-to-sales. If you’re considering PCTY for your portfolio, see our FREE research report to learn more.

Sprout Social (SPT)

Market Cap: $874.9 million

Born from the recognition that businesses needed a centralized way to handle their growing social media presence, Sprout Social (NASDAQ:SPT) provides a comprehensive software platform that helps businesses manage, analyze, and optimize their presence across various social media networks.

Why Is SPT Not Exciting?

1. Track record of operating margin losses stem from its decision to pursue growth instead of profits
2. Poor free cash flow margin of 7.6% for the last year limits its freedom to invest in growth initiatives, execute share buybacks, or pay dividends

At $14.88 per share, Sprout Social trades at 1.8x forward price-to-sales. Check out our free in-depth research report to learn more about why SPT doesn’t pass our bar.

Asure Software (ASUR)

Market Cap: $230.4 million

Operating in the often-overlooked smaller metropolitan markets where HR expertise can be scarce, Asure Software (NASDAQ:ASUR) provides cloud-based human capital management software and services that help small and medium-sized businesses manage payroll, taxes, time tracking, and HR compliance.

Why Are We Hesitant About ASUR?

1. Revenue increased by 14.3% annually over the last three years, acceptable on an absolute basis but tepid for a software company enjoying secular tailwinds
2. Products, pricing, or go-to-market strategy may need some adjustments as its 7.1% average billings growth over the last year was weak
3. Expenses have increased as a percentage of revenue over the last year as its operating margin fell by 3.2 percentage points

Asure Software’s stock price of $8.40 implies a valuation ratio of 1.5x forward price-to-sales. Read our free research report to see why you should think twice about including ASUR in your portfolio.

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