Stick With These Software Leaders

Sales of computer software could weaken over the next year, if a slowing economy prompts computer users to delay upgrades or new purchases.

That’s why we feel investors should stick with leading software makers like these five, whose size and customer base will help them stay profitable and generate cash flow for new product development. However, we see only three as buys right now.

MICROSOFT CORP. $34 (Nasdaq symbol MSFT; Aggressive Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 9.4 billion; Market cap: $319.6 billion; WSSF Rating: Above average) is the world’s largest maker of computer software. Its flagship products, the Windows operating system and the Office suite of business programs, dominate their markets.

Microsoft released its new Windows Vista operating system in early 2007. While initial sales were slow, strong sales of new computers (with pre-loaded copies of Vista) have helped spur demand. A planned upgrade to the Vista operating system should also convince more business users to switch.

In its first fiscal quarter ended September 30, 2007, Microsoft’s sales rose 27.8%, to $13.8 billion from $10.8 billion a year earlier. Earnings grew 28.6%, to $0.45 a share (total $4.3 billion) from $0.35 a share ($3.5 billion). The company spends around 13% of its revenue on research.

The stock now trades at 18.9 times the $1.80 a share the company should earn in fiscal 2008. The $0.44 dividend yields 1.3%.

Microsoft is investing heavily in its Internet operations. It recently paid $6 billion for aQuantive, Inc., which helps companies improve the effectiveness of their online advertising. It also paid $240 million for 1.6% of Facebook, the popular online social networking site. The investments should help Microsoft draw more traffic to its own online sites.

Microsoft is a buy.

ADOBE SYSTEMS INC. $42 (Nasdaq symbol ADBE; Aggressive Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 573.8 million; Market cap; $24.1 billion; WSSF Rating: Average) is best known for its Acrobat program, which lets users create electronic documents in the popular PDF format. However, Adobe gets nearly two-thirds of revenue from its Creative Solutions division, which help graphic designers create print publications and web pages.

Adobe is starting to realize some of the benefits of its 2005 acquisition of Macromedia Inc., the developer of Flash. This program lets web page creators add animation and other features that make their sites easier to use. Popular sites such as YouTube use Flash to play videos and other content.

Cellphones and other wireless devices that connect to the Internet represent a growing market for Flash. Adobe has licensed its mobile Flash technology to major cellphone makers such as Motorola and Samsung.

In its third fiscal quarter ended August 31, 2007, Adobe’s earnings before restructuring costs rose 55.2%, to $0.45 a share from $0.29 a year earlier. Sales rose 41.4%, to $851.7 million from $602.2 million. Adobe spent 19.2% of its revenue on research in the latest quarter. It’s debt free, and had $2.0 billion ($3.40 a share) in cash.

Adobe trades at a high 29.2 times the $1.44 a share it should earn in fiscal 2007. It also faces competition from freeware versions of some of its software.

Adobe is a hold.

SYMANTEC CORP. $18 (Nasdaq symbol SYMC; Aggressive Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 867.3 million; Market cap: $15.6 billion; WSSF Rating: Average) makes software that helps protect computers from viruses and electronic attacks. Its best known product is the top-selling Norton Anti-Virus program.

Symantec continues to cut its reliance on sales to consumers by increasing its corporate operations. Security products and services for businesses also give it steadier revenue streams than consumer software sales.

As part of this strategy, Symantec recently acquired Altiris Inc. for $1.05 billion. Altiris’s products let computer administrators easily install and manage software across a wide variety of computers attached to a network.

The company has also agreed to buy Vontu Inc. for $350 million. Vontu’s software helps companies secure sensitive data. Symantec has worked with Vontu for several years, and its familiarity with Vontu’s products reduces the risk of this purchase.

In its second fiscal quarter ended September 30, 2007, Symantec’s revenue rose 12.7%, to $1.42 billion from $1.26 billion a year earlier. Earnings before restructuring costs rose just 0.8%, to $263 million from $261 million. However, per-share earnings grew 11.5%, to $0.29 from $0.26, due to Symantec’s aggressive share repurchases.

The stock has moved down lately on fears that a slowing economy could force companies to spend less on new software. However, it now trades at 16.4 times the $1.10 a share Symantec should earn in fiscal 2008. That’s cheap in when you consider that the company spends 16% of its revenue on research. New products from these outlays should help fuel Symantec’s longterm growth.

Symantec is a buy.

AUTODESK INC. $47 (Nasdaq symbol ADSK; Aggressive Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 231.7 million; Market cap: $10.9 billion; WSSF Rating: Average) makes AutoCAD, the world’s leading computer aided design program. AutoCAD helps engineers and architects design machinery and buildings, and supplies 90% of Autodesk’s revenue. The remaining 10% comes from software that filmmakers use to create special effects.

Autodesk spends over 20% of its revenue on research. This helps it maintain its dominance in its niche markets. Heavy research spending is also helping Autodesk transform its software, from the traditional 2D models to 3D. That speeds up the design process and improves the quality of the final product or structure.

Autodesk is also using acquisitions to strengthen its 3D expertise. In June 2007, it paid $29.1 million for UK-based 3D specialist NavisWorks.

Thanks to this purchase, revenue from 3D products in Autodesk’s third fiscal quarter ended October 31, 2007 rose 32% from a year earlier, and accounted for 24% of total revenues. Overall revenue for the quarter rose 17.9%, to $538.4 million from $456.8 million. Earnings rose 40.0%, to $0.49 a share (total $117.1 million) from $0.35 a share ($86.3 million).

Autodesk is also using acquisitions to expand in other areas. For example, it has agreed to pay $42.5 million for French software developer Robobat, which makes design software for the structural engineering industry. Growing by acquisition adds risk, but Autodesk should have little trouble integrating small purchases like this.

The stock has rebounded since Autodesk fixed problems with the way it accounted for stock options earlier this year. But at 29.4 times its forecast fiscal 2008 earnings of $1.60 a share, Autodesk needs substantial growth to move higher.

Autodesk is a hold.

FAIR ISAAC CORP. $38 (New York symbol FIC; Aggressive Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 55.4 million; Market cap: $2.1 billion; WSSF Rating: Average) makes software that helps banks and businesses calculate the likelihood that a borrower will pay back a loan. Its FICO credit scoring system is now an industry standard. The company also makes software that help businesses detect fraudulent transactions.

In the fiscal year ended September 30, 2007, Fair Isaac’s revenue fell 0.4%, to $822.2 million from $825.4 million. Earnings grew 1.2%, to $104.7 million from $103.5 million in the prior year.

However, per-share earnings jumped 14.5%, to $1.82 from $1.59. That’s because the company repurchased $451.1 million of its stock. Fair Isaac spent 8.6% of its revenue on research in fiscal 2007.

Fair Isaac faces competition from a new credit scoring system developed by three leading credit bureaus. The drop in housing sales has also hurt demand for its FICO scores.

However, the company is now streamlining its product offerings and attracting larger customers. It’s cutting administrative staff and adding revenue-generating sales and client support employees. It also expanding its overseas operations. It recently opened an office in China, and is working with some of that country’s largest financial institutions.

Fair Isaac’s stock trades at a reasonable 19.0 times the $2.00 a share it should earn in 2008. The $0.08 dividend yields 0.2%.

Fair Isaac is a buy.