Morningstar Software Stock Picks: Microsoft and ServiceNow Recommended Amid AI Fears

Morningstar recently assessed that widespread fears concerning AI’s impact on software stocks are largely exaggerated. The financial research firm introduced specific Morningstar software stock picks, recommending Microsoft and ServiceNow as prime buying opportunities.

This comes despite a recent tech market sell-off, which has been driven by investor concerns regarding artificial intelligence.

What Happened

The software stock sector experienced a notable downturn as fears of disruption grew. Anthropic’s Claude AI assistant specifically raised concerns among investors. Many envisioned a future where this AI could potentially render numerous companies and IT departments obsolete.

The iShares Expanded Tech-Software Sector ETF (IGV) reflected this sentiment, falling 19% between January 26 and February 5. However, the software stock market rallied on Friday, with the IGV rising 3% and the Nasdaq up more than 2%.

Details From Sources

Morningstar’s Perspective on AI Fears

Dan Romanoff, a senior equity analyst at Morningstar, believes these fears are “largely overdone.” According to Romanoff, as reported by Business Insider, the recent sell-off presents a “prime dip-buying opportunity.” He stated that there is “little evidence that the bear case is unfolding,” noting that “retention rates and other software metrics appear solid.” Romanoff also attributes the view that enterprise software customers will not “vibe code internal solutions.”

Limited AI Revenue Generation

Romanoff observed that “AI products are not generating substantial revenue for software vendors.” He explained that management teams often fear “hallucinations and rogue agents” from AI solutions. Disclosures from public software companies generally show AI solutions account for approximately 2% of revenue (or ARR). Romanoff also mentioned that OpenAI’s revenue “skews heavily toward consumer subscriptions.”

Historical Context and Automation

Romanoff drew historical parallels to prior automation instances that did not cause major labor market disruptions. He referenced Salesforce’s CRM approach 25 years ago, which concerned sales reps and automation. Romanoff stated that “seat counts may be pressured at some point in the future,” but currently there is “no evidence to show that this is happening.”

Specific Stock Recommendations

Morningstar specifically recommends Microsoft (MSFT) and ServiceNow (NOW), projecting “substantial upside” for both. Microsoft shares are down 17% year to date, while ServiceNow shares are down 35% year to date. Romanoff provided a “fair value estimate” of $600 for Microsoft, implying a 50% upside. For ServiceNow, his estimate is $200, representing a 100% upside. This Microsoft stock forecast and ServiceNow investment analysis highlights potential value. Romanoff cautioned, “The software landscape is not for the faint of heart at present,” acknowledging market volatility.

Why This Matters

Morningstar’s analysis offers a contrarian view for investors concerned about the significant AI impact on software sector. The recent tech market sell-off might present specific buying opportunities for those looking for undervalued assets.

Background Context

The initial investor sentiment regarding AI disruption, specifically concerning Anthropic’s Claude AI, created a dire outlook for software stocks. This led to a market response where the iShares Expanded Tech-Software Sector ETF (IGV) saw a significant drop before its recent Friday rally.

Industry Reactions

Industry sentiments, as synthesized through Morningstar’s analyst, indicate management teams express skepticism and fears concerning AI products. These fears mainly revolve around potential “hallucinations and rogue agents” within AI solutions.

Related Data or Statistics

• The iShares Expanded Tech-Software Sector ETF (IGV) fell 19% from January 26 to February 5.
• AI solutions account for approximately 2% of revenue (or ARR) for publicly traded software companies.
• OpenAI’s revenue skews heavily toward consumer subscriptions.
• Microsoft (MSFT) shares are down 17% year to date.
• ServiceNow (NOW) shares are down 35% year to date.
• Morningstar’s fair value estimate for Microsoft is $600, implying 50% upside.
• Morningstar’s fair value estimate for ServiceNow is $200, representing 100% upside.
• The IGV rose 3% and the Nasdaq was up more than 2% on Friday.

Future Implications (SPECULATIVE)

Dan Romanoff acknowledged that “seat counts may be pressured at some point in the future.” However, he emphasized that there is currently “no evidence to show that this is happening.” Romanoff also reiterated that automation itself is not a new trend.

Conclusion

Morningstar’s overall assessment suggests that fears concerning the AI impact on software may be exaggerated. The firm maintains confidence in specific Morningstar software stock picks, such as Microsoft and ServiceNow, as potential value investments. Investors should remain mindful of ongoing market volatility.

Call-to-Action

Investors interested in software stocks should consider Morningstar’s analysis and consult a financial advisor for personalized investment advice.

FAQ Section

• Q1: What are Morningstar’s recommended software stock picks despite AI concerns?
  A1: Morningstar recommends Microsoft and ServiceNow as buying opportunities.
• Q2: Why did software stocks experience a recent sell-off?
  A2: Software stocks were battered due to concerns that Anthropic’s Claude AI assistant could disrupt the industry.
• Q3: How much revenue do AI solutions currently generate for software vendors, according to Morningstar?
  A3: Disclosures from publicly traded software companies generally indicate that AI solutions account for approximately 2% of revenue (or ARR).
• Q4: What are Morningstar’s fair value estimates for Microsoft and ServiceNow?
  A4: Morningstar has a $600 fair value estimate for Microsoft (50% upside) and $200 for ServiceNow (100% upside).
• Q5: What is Morningstar’s perspective on the long-term threat of AI to software?
  A5: Morningstar believes fears are largely overdone, seeing little evidence of the bear case unfolding and noting that automation is not a new trend, though “seat counts may be pressured at some point in the future.”