Internet Software & Services Industry Outlook: Resilience Amid Economic Slowdown

The Internet-Software & Services industry currently faces challenges stemming from a slow economy. Traditionally sensitive to economic shifts, the industry’s forecasts have fluctuated throughout the past year as interest rate projections changed. Many companies are focused on cutting costs, with operating expenses decreasing to maintain profitability despite lower revenue. Investment in capital projects is being restrained, unless by certain key players.

In this environment, companies such as RingCentral (RNG) and Criteo (CRTO) are distinguishing themselves for several reasons. They are effectively leveraging artificial intelligence (AI), which supports revenue growth and mitigates the effects of the current economic downturn. Furthermore, they have successfully established systems for client retention through subscription models and various platforms.

As a crucial component of the digital economy, it is difficult to envision the long-term decline of this industry. Its diversity creates complexities; however, recent months have shown an upward trend in industry valuations.

Overview of the Industry

The Internet Software & Services industry is relatively compact, primarily focusing on facilitating platforms, networks, and services for online enterprises while enhancing customer interaction with Internet-based services.

Key Themes Influencing the Industry

• Technology Adoption: The growth of businesses in this sector heavily relies on technology uptake. Companies that have established their platforms are now advancing the use of AI, while others strive to keep pace to remain competitive. This push for modernization is accelerating technology adoption, particularly for data collection and analysis, whether on-premise or in the cloud. The emergence of numerous cloud-first companies is driving a consistent demand for Internet-delivered software and services.

• Economic Conditions: Despite recent rate cuts, the economy continues to decelerate, posing challenges for an industry that prospers during strong economic conditions. An economic slowdown typically results in customers opting to purchase fewer software and services. Additionally, geopolitical tensions, particularly in Europe and the Middle East, are impacting oil prices and supply chains, contributing to economic uncertainty. Consequently, the outlook for 2025 is still not very clear.

• Volatile Markets and Stability Preferences: The current political climate significantly affects the performance of individual companies within the industry. Serving a diverse array of markets adds to the unpredictability of outcomes for the sector. However, many players are increasingly adopting a subscription-based model, which lends relative stability and allows companies with critical offerings to maintain core customer bases while adjusting prices as needed.

• Infrastructure Needs: The shift towards cloud operations and heightened demand for supporting software and services necessitates significant infrastructure investments, increasing costs for companies. This leads to fluctuations in profitability as new infrastructure depreciates and debt levels are managed. Nevertheless, many industry players have successfully reduced debt over the past few years, positively impacting their financial standing.

Zacks Industry Rank Shows Potential for Growth

The Zacks Internet – Software & Services industry falls within the broader Zacks Computer and Technology sector. Presently, it holds a Zacks Industry Rank of #45, positioning it in the top 18% of around 250 classified industries.

This favorable Zacks Industry Rank reflects strong growth potential in the sector. Historically, industries ranked in the top half have outperformed those in the bottom half by a ratio exceeding 2 to 1. However, caution is warranted regarding recent aggregate estimate revisions. Both fiscal year 2025 and 2026 estimates have seen considerable fluctuations, with the 2025 estimate steady through July 2024, experiencing a decline in August, then rising again briefly before tapering off. Similarly, the 2026 estimate reflected a comparable pattern of ups and downs. Overall, estimates have weakened over the past year.

Before diving into stock recommendations, let’s examine the recent performance and valuation landscape of the industry.

Improving Stock Market Performance

The Zacks Internet – Software & Services Industry lagged behind both the broader Zacks Computer and Technology Sector and the S&P 500 for much of 2024. However, it reversed this trend starting in February and outperformed both benchmarks this month.

The industry recorded a return of 9.5% over the past year, compared to 7.1% for the broader sector and 8.8% for the S&P 500.

One-Year Price Performance

Image Source: Zacks Investment Research

Current Valuation Insights

The industry is trading at a forward 12-month price-to-earnings (P/E) ratio of 22.3X. This represents a 7.4% premium over the S&P 500 and a 7.0% discount compared to the broader technology sector. Historically, technology stocks command higher multiples due to investor preference for innovation. Notably, the current multiple exceeds the industry’s median level of 18.3X observed over the past year.

The industry has fluctuated within a range of 16.4X to 24.1X during the previous year, as illustrated in the chart below.

Forward 12 Month Price-to-Earnings (P/E) Ratio

Image Source: Zacks Investment Research

Two Stocks to Consider

RingCentral Inc. (RNG): Based in Belmont, California, RingCentral’s AI-driven product suite includes Unified Communications as a Service (UCaaS), Contact Center as a Service (CCaaS), Video & Events, and RingSense AI solutions. Its achievements are not only attributed to innovative communication and collaboration offerings but also to a diverse network of strategic partners, global providers, channel partners, and third-party developers.

The company’s latest AI initiatives…