Investors Increase Scrutiny on Software Stocks Due to AI Disruption Concerns

For years, software companies have reigned supreme on Wall Street, celebrated for their robust profit margins, minimal capital requirements, and enormous growth potential. This led venture capitalist Marc Andreessen to famously declare in 2011 that “software is eating the world.”

Fast forward fourteen years, and artificial intelligence is stirring similar enthusiasm, prompting some investors to anticipate a major shift where AI takes center stage within the software industry.

This year, Salesforce, Adobe, and ServiceNow have emerged among the weakest performers in the S&P 500, each experiencing a decline of at least 17%, which has collectively resulted in a market value drop of approximately $160 billion. After a single monthly dip in the last 18 months, investors began withdrawing funds from the software and services sector for two straight months leading up to June, according to EPFR data.

A Morgan Stanley grouping of software-as-a-service stocks has slipped over 6% this year, in stark contrast to an 11% increase for the tech-heavy Nasdaq 100. While the bank does not publicly disclose the specific stocks in this group, companies such as Asana, HubSpot, Bill Holdings, and Vertex rank among the most substantial underperformers, each down at least 29%.

While AI has the potential to disrupt various sectors, including education and staffing, investors are particularly wary of software companies that create the fundamental code for digital services, such as customer relationship management and back-office functionalities.

“Technological obsolescence can occur without warning,” said Robert Ruggirello, chief investment officer at Brave Eagle Wealth Management. “It’s understandable that investors are exercising caution.”

Despite the hurdles faced by share prices, investor sentiment toward the sector remains complex. Leading software developers like Microsoft Corp, Oracle Corp, and Palantir Technologies have emerged among the top performers in the S&P 500 this year.

The difference for these companies lies in their proactive approach to AI, rather than simply defending their current market positions. These tech giants are pouring billions into product development and enhancing their AI computing capabilities.

Meta Platforms is witnessing strong revenue growth as its AI initiatives improve advertising targeting and consumer engagement. Palantir’s AI solutions are projected to contribute to a 45% increase in sales this year. Additionally, companies like CrowdStrike Holdings and other cybersecurity firms are thriving, as investors believe their products are less vulnerable to easy replication by AI.

However, for numerous other software firms, the threat posed by AI is quite real, challenging the sector’s value proposition of offering premium-priced digital tools that enhance productivity. If cost-sensitive clients like banks or retailers can find nearly identical services at lower prices, entire business models could falter.

While it’s uncertain whether AI can replace Asana’s work management system, a slowdown in new client acquisitions early this year raised significant investor concerns, leading to a steep drop in share prices. Similarly, HubSpot has potential to adapt to AI, yet investors remain anxious about escalating competition for its CRM tools.

The same worries apply to Monday.com. Though its software centralizes workflow processes and isn’t at risk of obsolescence, investors fear growth could be stunted by AI. A disappointing revenue forecast on August 11 triggered a sell-off, causing a 30% decrease in share price that day.

“Any business dependent on outdated technology is bound to encounter difficulties or require significant transformation, which will be reflected in their stock performance unless they succeed,” stated Mark Bronzo, chief investment strategist at the Rye Consulting Group.

Currently, investors are divesting from software companies that lack compelling AI strategies or robust defenses against the advancing technology.

“In earlier times, if Salesforce had become undervalued relative to its historical metrics, investors would have returned to buy shares,” Bronzo observed. “That mentality seems to be absent at this moment.”

This trend is not limited to U.S. borders. SAP SE, Europe’s largest firm by market value, has suffered declines alongside smaller competitors such as Sage Group Plc and Dassault Systemes SE, following Monday.com’s announcement.

With OpenAI’s ChatGPT currently catering to about 700 million weekly users, Ruggirello likens software companies to “an energy company realizing a competitor the size of Exxon has entered their market.”

This apprehension is evident in the sector’s valuations, which have historically been significantly higher than the broader market due to rapid sales growth and subscription-based revenue models, both of which are highly favored by Wall Street.

This month, the Morgan Stanley software basket was valued at 23 times projected earnings, about half the average of the past decade and the lowest recorded in Bloomberg data since 2014. In contrast, the Nasdaq 100 trades just below 27 times forecast earnings.

UBS strategists pointed out that the downturn in certain areas of the software sector might present new opportunities. They suggested earlier this month that investors explore internet and software companies that are lagging in the AI movement.

“While AI revenue growth has not yet matched the industry’s aggressive spending, promising trends in monetization and AI adoption are emerging,” wrote strategists led by Ulrike Hoffmann-Burchardi, chief investment officer for the Americas and global head of equities, in a research note.

Nonetheless, a distinct sense of caution lingers among investors regarding software companies at this time.

Over the last two decades leading up to the 2021 market peak, no other industry group in the S&P 500 experienced as significant an increase in its weight within the index as the software and services sector, which surged from below 6% to nearly 14.5%, even after major stocks like Google, Facebook, and Amazon.com were reclassified into other categories in 2018.

The software group’s representation in the market capitalization-weighted S&P 500 currently hovers around 12% of the total index, even as it has been surpassed by semiconductor firms experiencing a surge in demand for computing hardware. Without the stellar performance of Microsoft, Oracle, and Palantir, the software sector’s weight would likely be even lower.

“The sentiment indicates that risk levels have escalated significantly, with no clarity in sight,” remarked Ruggirello from Brave Eagle. “At present, it’s evident that only a few companies like Meta and Microsoft are thriving, while many others are struggling.”

© 2025 Bloomberg

Stay updated with Moneyweb’s comprehensive finance and business news via WhatsApp here.