The past two years have been a very challenging time to invest in tech stocks. Software stocks have experienced an apocalyptic sell-off. Even though most defensive tech stocks have pulled back by more than 30% in the past year or two.
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AI could be an opportunity for the smartest tech stocks
Certainly, any major drawdown can make an investor question their investment thesis. Yet, sometimes broad narrative fears just don’t play out the way the market initially thinks. Even though artificial intelligence (AI) is a major disruptive force, many incumbent software providers could be major beneficiaries.
They already have the established customer base. AI is improving software maintenance and development costs. This could help improve overall margins.
Likewise, software providers can implement new AI solutions for customers and efficiently add new service modules. If incumbents are smart, they will use AI applications to further enhance their competitive market position.
Constellation Software: A top tech stock at an attractive price
One tech stock that appears to be well-positioned is Constellation Software (TSX: CSU). It operates over 1,000 niche vertical market software businesses across the world. These businesses cater to very specific markets, are heavily entrenched with customers, and generally have very low churn.
Constellation operates a very decentralized, competitive company. The best returning businesses get the most capital to invest, as do the highest returning acquisition opportunities. Constellation is likely to be very thoughtful about how it deploys capital in this new AI-world.
If AI provides better opportunities to focus on organic growth opportunities, it is likely to do so. However, acquisitions will likely continue to be its major growth engine.
With public tech stocks declining to more reasonable valuations, private tech companies are also likely to see a similar valuation correction. Already, private equity is starting to vacate the software space. This could mean potentially better valuations (and higher returns) for Constellation.
With its stock down 46% in the past year, Constellation’s valuation looks attractive. At an 8% free cash flow yield, it looks interesting given that it is likely to grow at double that rate this year.
Descartes Systems: A global network that is tough to disrupt
Descartes Systems Group (TSX: DSG) is another top tech stock that could benefit from AI. Along with a full suite of transportation, logistics, and e-commerce software, Descartes operates a proprietary global logistics network.
It connects over 170,000 parties across 140 countries with a substantial amount of global trade operating through the platform. This is not something AI can easily displace, especially when the data is held by Descartes.
If anything, Descartes can use AI to help add solution modules. The company is only getting started using AI to unlock new customer solutions. This could help fuel strong organic growth ahead. The company has already been taking market share over the past year. With so much trade disruption, Descartes tends to win more customers when the shipping environment is more volatile.
Descartes has everything to like in a quality tech stock: a cash-rich balance sheet, opportunities to consolidate other smaller software vendors, strong profitability/cash flows, and a large market to win. Its stock is down 30% in the past year. It trades at its cheapest valuation in 10 years.
The Foolish takeaway
While the market is pricing major disruptions against Constellation Software and Descartes Systems, the market isn’t always right. In fact, AI could be a major opportunity for these high-quality tech stocks. If you don’t mind investing against the flow, these bargains are ripe for the picking today.
