The Software Trick: Find a Niche

S&P favors Citrix Systems because of its focus on the growing mobile workforce; design vendors such as Autodesk benefit from hot growth in Asia

by Karyn McCormack

In the fiercely competitive software area, finding a niche and sticking with it can be a road to success. So says Jim Yin, who follows systems and applications software companies for Standard & Poor's Equity Research. His favorite stock at the moment is Citrix Systems (CTXS), which makes software that allows workers to easily and securely work from home or on the road. He's also high on design software vendors like Autodesk (ADSK).

Not all software stocks behave the same way, so investors should choose carefully. In fact, year-to-date through Apr. 20, systems software stocks have been flat, while applications software stocks have risen 7.5% vs. a 4.7% gain for the S&P 500 index, Yin notes.

BusinessWeek.com's Karyn McCormack spoke with Yin on Apr. 23 about his favorite software stocks. Edited excerpts from their conversation follow:

Note: Jim Yin is an S&P Equity Research analyst. He has no ownership interest in or affiliation with any of the companies on which he writes research. All of the views expressed here accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed.

What's your investment opinion for the systems software group?

I have a neutral outlook on the systems software industry. First, my overall view of the economy is things are still progressing along, but we're seeing some weaknesses in the U.S. The IT (information technology) spending environment is solid and we think it will grow moderately. IT spending is expected to grow in the low- to mid-single digits, and we think software will probably get a larger piece of the total IT budgets. Based on IDC data, we think software spending will be up 5% to 8% this year.

Even though I'm optimistic for strong revenue growth of network security, we think that's offset by increasing competition, especially from some of the hardware makers like EMC (EMC) and Cisco Systems (CSCO)—which is trying to get into the security software space. Their entrance will pressure Symantec (SYMC) and McAfee (MFE), which provide anti-virus and other security software. We think that anti-virus should be part of the complete solution that includes firewall, data backup, and recovery. Competition should increase among the players as they expand their product offerings.

We're also seeing continued growth of Linux. So far its presence has been limited predominately to servers, displacing Unix. Red Hat (RHT) has prospered from the growth of Linux. However its future has been clouded by the entrance of Oracle (ORCL), and the partnership between Microsoft (MSFT) and Novell (NOVL). Eventually, we see Linux as a possible competitor to Microsoft Windows on the desktop. Dell (DELL) is considering putting Linux pre-installed on PCs as an option based on users' feedback.

What are your some of your favorite stocks, and why?

The software business is highly scalable, and once you become a leader you can become the de facto standard. I like companies that have a strong market niche so that other companies can't displace them.