In this article, I evaluated two software stocks, Microsoft Corporation (MSFT) and Tyler Technologies, Inc. (TYL), to determine which has the potential for better returns. We believe MSFT is the better investment for October for reasons explained throughout this piece.

The COVID-19 pandemic has sped up digital transformation by several months and years. Organizations worldwide attempt to implement digital technologies to automate their business processes to remain competitive, boost productivity and efficiency, lower operational costs, facilitate quick decision-making, and provide new revenue.

In recent years, there has been an increased digitalization among enterprises across end-use industries, including retail, healthcare, manufacturing, and transportation. This encompasses, among others, moving data to the cloud, using tech devices and tools for communication and collaboration, and automating operations.

By 2026, global digital transformation spending is projected to reach 3.40 trillion.

The global business software and services market is expected to reach $1.15 trillion by 2030, expanding at a CAGR of 11.9%. The demand for enterprise software and services would be driven by growing digitalization globally and an increase in the volume of enterprise data.

Meanwhile, the U.S. business software and services market is expected to grow at a CAGR of 10.7% from 2023 to 2030.

Furthermore, the growing adoption of innovative technologies among organizations, such as Artificial Intelligence (AI), blockchain, Machine Learning (ML), hybrid infrastructure, metaverse, and extended reality, drive the industry’s prospects.

According to Gartner Digital Markets’ 2023 SMB Software Buying Trends Survey, emerging technology plays an integral part in the IT strategy of 57% of businesses, with most being comfortable early adopters of new technology.

Despite a challenging macro environment, the spending on software and services will remain robust this year. The global software spending is estimated to grow by 13.7% year-over-year to $922.75 billion in 2023, as per the forecast by Gartner.

This year, the software segment will witness double-digit growth as enterprises boost utilization and reallocate spending to core applications and platforms that support efficiency gains, such as enterprise resource planning (ERP) and customer relationship management (CRM) applications.

The software industry’s tailwinds should bode well for MSFT and TYL.

MSFT is a clear winner in nine-month price performance, with 30.8% returns compared to TYL’s 19% gain. MSFT surged 30.2% year-to-date compared to TYL 18.1% gain. In addition, MSFT’s 31.5% gain over the past year is higher than TYL’s gain of 11.1%.

Here are the reasons why we think MSFT could perform better in the near term:

Latest Developments

On September 19, MSFT’s board of directors declared a quarterly dividend of $0.75 per share, representing an increase of 10% over the prior quarter’s dividend. The dividend is payable on December 14 to shareholders of record on November 16. Its annual dividend of $3 translates to a yield of 0.96% on prevailing prices. Its four-year average dividend yield is 0.94%.

The company’s dividend payouts have grown at a CAGR of 10.1% over the past five years. Moreover, MSFT has raised its dividend for consecutive 18 years. The latest increase in the quarterly dividend reflects the company’s strong financial position.

On August 8, TYL acquired Computing System Innovations, LLC (CSI), a company that provides the leading AI automation, redaction, and indexing solution for courts, recorders, and attorneys. With this acquisition, Tyler adds CSI’s AI-driven redaction and indexing solution to its portfolio, bringing automated data entry and document processing options to current clients.

In addition, the company plans to leverage CSI’s AI and automation technology across other Tyler verticals such as Municipal & Schools, Property & Recording, and Platform Solutions.

Recent Financial Results

TYL’s revenues rose 7.6% year-over-year to $504.28 million for the second quarter that ended June 30, 2023. Its non-GAAP operating income was $115.91 million, an increase of 4.8% year-over-year. Its adjusted EBITDA rose 5.4% from the year-ago value to $125.50 million. Its non-GAAP net income and EPS grew 8.1% and 6.9% year-over-year to $85.93 million and $2.01, respectively.

However, the company’s cash flows from operations were negative $19.20 million, compared to $76.70 million for the second quarter of 2022. Its free cash flow was negative $33.20 million, compared to $60 million for the previous year’s quarter.

For the fourth quarter that ended June 30, 2023, MSFT’s total revenue grew 8.3% year-over-year to $56.19 billion, and its gross margin came in at $39.39 billion, an increase of 11.2% year-over-year. The company’s operating income rose 18.1% from the year-ago value to $24.25 billion.

Furthermore, MSFT’s net income and EPS increased 20% and 20.6% from the prior-year quarter to $20.08 billion and $2.69, respectively. As of June 30, 2023, the company’s cash and cash equivalents stood at $34.70 billion, compared to $13.93 billion as of June 30. 2022.

Past And Expected Financial Performance

MSFT’s revenue has grown at a CAGR of 14% over the past three years. Its EBITDA has increased at a CAGR of 16.1% over the same period, while its net income and EPS have grown at CAGRs of 17.8% and 18.9%, respectively. In addition, over the same time frame, the company’s total assets have increased at a CAGR of 11%.

Analysts expect MSFT’s revenue and EPS for the first quarter (ending September 2023) to increase 8.8% and 12.6% year-over-year to $54.53 billion and $2.65, respectively. Also, the company’s revenue and EPS for the fiscal year (ending June 2024) are expected to grow 11.3% and 12.2% from the previous year to $235.85 billion and $11.01, respectively.

Over the past three years, TYL’s revenue and EBITDA have grown at 19.6% and 14.8% CAGRs, respectively. The company’s total assets have increased at a CAGR of 24.8%. However, its net income and EPS have decreased at CAGRs of 4.5% and 4.5%, respectively.

For the third quarter (ended September 2023), TYL’s revenue and EPS are expected to grow 5% and decline 3.5% year-over-year to $496.97 million and $1.99, respectively. Furthermore, analysts expect the company’s revenue and EPS for the fiscal year (ending December 2023) to increase 5.9% and 2.4% year-over-year to $1.96 billion and $7.68, respectively.

Profitability

MSFT’s trailing-12-month revenue is 111.5 times what TYL generates. Moreover, MSFT is more profitable, with a trailing-12-month gross profit margin of 68.92% compared to TYL’s 43.18%. Also, MSFT’s trailing-12-month EBIT margin and net income margin of 41.77% and 34.15% are higher than TYL’s 11.13% and 8.64%, respectively.

In addition, MSFT’s trailing-12-month ROE, ROA, and ROTC of 38.82%, 19.17%, and 20.85% are higher than TYL’s 6.29%, 4.18%, and 3.55%, respectively. MSFT’s trailing-12-month levered FCF margin of 22.31% compared to TYL’s 16.61%.

Valuation

In terms of trailing-12-month non-GAAP P/E, MSFT is currently trading at 31.82x, 37.4% lower than TYL, which is trading at 50.85x. MSFT’s forward EV/EBITDA multiple of 19.52 is lower than TYL’s 34.52. Also, MSFT’s trailing-12-month Price/Cash Flow of 26.48x is lower than TYL’s 52.24x.

Thus, MSFT is relatively more affordable.

POWR Ratings

MSFT has an overall rating of B, which equates to a Buy in our proprietary POWR Ratings system. Conversely, TYL has an overall rating of C, translating to a Neutral. The POWR Ratings are calculated considering 118 different factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight distinct categories. MSFT has a grade of B for Quality, in sync with its higher profitability relative to its peers. The stock’s trialing-12-month EBITDA and gross profit margins of 48.14% and 68.92% compare favorably to industry averages of 9.15% and 48.82%, respectively.

In addition, TYL has a grade of C for Value, in sync with its mixed profitability. The stock’s trailing-12-month EBITDA margin of 16.67% is 82.1% higher than the industry average of 9.15%. However, its trailing-12-month gross profit margin of 43.18% is 11.6% lower than the 48.82% industry average.

Of the 45 stocks in the Software - Business industry, MSFT is ranked #10, while TYL is ranked #25.

Beyond what we’ve stated above, we have also rated both stocks for Sentiment, Growth, Momentum, Stability, and Value. Click here to view MSFT ratings. Get all TYL ratings here.

The Winner

The solid demand for business software solutions driven by the rising automation of business processes across end-use industries, an increase in the volume of enterprise data, and the growing adoption of emerging technologies would provide several growth opportunities for software companies.

Hence, software stocks MSFT and TYL will likely benefit from the industry’s tailwinds. However, TYL’s relatively weak financials, low profitability, elevated valuation, and bleak growth prospects make its rival, MSFT, the better buy for October.

Our research shows that the odds of success increase when one invests in stocks with an Overall Rating of Strong Buy or Buy. View all the top-rated stocks in the Software - Business industry here.

What To Do Next?

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MSFT shares rose $1.60 (+0.51%) in premarket trading Wednesday. Year-to-date, MSFT has gained 31.82%, versus a 13.06% rise in the benchmark S&P 500 index during the same period.

Mangeet’s keen interest in the stock market led her to become an investment researcher and financial journalist. Using her fundamental approach to analyzing stocks, Mangeet’s looks to help retail investors understand the underlying factors before making investment decisions.

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