The Software Stock Market is on Fire - and It's Going to Be a Great Year for It

After a strong surge in semiconductor stocks, smaller software companies are now taking the spotlight—potentially signaling further growth opportunities across the sector.

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While chip stocks have experienced volatility this year due to concerns about overbuilding AI infrastructure following DeepSeek’s developments and the impact of tariffs, software stocks are emerging as a more stable investment. These companies and their clients could benefit significantly from DeepSeek’s advancements, especially if computing costs continue to decline.

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So far in 2025, software stocks have slightly outperformed semiconductor stocks, but the contrast becomes more evident when looking at the past six months. The iShares Expanded Tech-Software Sector ETF (IGV), which tracks the S&P North American Expanded Technology Software Index, has gained approximately 27% in that period. Meanwhile, the iShares Semiconductor ETF (SOXX), which follows the ICE Semiconductor Index, has grown by less than 1%, highlighting the relative underperformance of chip stocks.

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Investors appear to be increasing their exposure to software stocks, with some even shifting away from semiconductors in their portfolios. Brendan Connaughton, founder and managing partner of Catalyst Private Wealth, noted that this shift is actively discussed among institutional investors. He pointed out that software companies tend to deliver steadier, more predictable revenue growth compared to the semiconductor sector, which faced unexpected challenges following DeepSeek’s impact.

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Software businesses also have the advantage of licensing revenue, which provides stability, even if it means slightly slower growth. Moreover, many companies are introducing usage-based pricing models for AI-driven features, allowing them to charge customers based on actual utilization rather than just licensing fees.

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Another factor working in favor of software firms is that their products are delivered via the cloud and housed in data centers rather than being physical goods. This reduces exposure to supply chain disruptions and tariffs, which have been concerns for hardware manufacturers.

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During the current earnings season, software companies in the S&P 500 have reported an average revenue growth rate of 12.15% for the fourth quarter, according to FactSet. In comparison, semiconductor and equipment firms have recorded 11.34% revenue growth.

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However, Nvidia Corp. (NVDA), which is set to report earnings later this month, is expected to post a 72% increase in revenue for its fiscal first quarter.

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When factoring in both reported results and estimates for companies yet to disclose earnings, semiconductor companies within the S&P 500 are projected to see a blended growth rate of 24.6%, compared to 11.7% for software firms.

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Despite this, some of the strongest-performing software companies recently have been smaller, high-growth firms outside the S&P 500. For instance, Monday.com Ltd. (MNDY), a project-management software provider, posted 32% revenue growth in its latest quarter, surpassing expectations and driving its stock up 27% after earnings. Similarly, data-streaming platform Confluent Inc. (CFLT) reported 23% revenue growth, leading to a 25% increase in its share price in the session following its earnings release.

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Jordan Klein, a managing director and technology, media, and telecom (TMT) specialist at Mizuho Securities, observed that software remains a favorite sector among institutional investors seeking promising long-term plays. While larger software companies have struggled to gain traction, investors have been eager to buy into small and mid-cap software stocks. Klein noted that failing to hold enough of these names could mean underperforming against the broader tech sector or key benchmarks.

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The sustainability of software’s current momentum remains uncertain. AI continues to be a primary focus for investors, influencing corporate spending decisions and efficiency expectations. While hardware manufacturers have already experienced an AI-driven surge, software has yet to fully capitalize on the trend. Furthermore, major cloud and hyperscale companies’ capital expenditure plans could still provide substantial tailwinds for semiconductor firms.

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Connaughton remains cautious about writing off semiconductor stocks entirely, despite their recent struggles. “I don’t want to discard chips just because they hit a rough patch,” he stated. “Both sectors have potential, but success will ultimately come down to individual companies’ ability to execute and tap into high-growth areas. The addressable market for enterprise software is enormous.”

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DeepSeek’s impact may offer long-term benefits to software developers. Patrick Walravens, head of technology equity research at Citizens JMP, pointed out that application providers are currently faring better than infrastructure providers. “The biggest takeaway from DeepSeek is that the declining cost of computing will benefit application developers,” he explained. Companies that rely on AI models for inference—using them to generate predictions, responses, and insights—could see lower operating costs.

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Palantir Technologies Inc. (PLTR) Chief Technology Officer Shyam Sankar recently emphasized that inference costs are dropping rapidly, which could have significant implications for software firms.

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As AI adoption accelerates, demand for software tailored for data centers—including corporate, cloud, and AI-specific facilities—is expected to grow. Mizuho analyst Gregg Moskovitz noted that demand for software solutions, particularly in data analytics and software-as-a-service (SaaS), is improving. Cybersecurity software also remains a strong segment. “There is increasing activity around companies preparing their data infrastructure for the AI wave,” Moskovitz observed.

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Additionally, several software firms are streamlining operations, a strategy that often appeals to Wall Street. In recent weeks, Okta Inc. (OKTA), Workday Inc. (WDAY), and Salesforce Inc. (CRM) have all announced layoffs, which initially provided a boost to their stock prices.

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However, Salesforce later lost much of that momentum after revealing that Chief Operating Officer Brian Millham will retire in May, with board member Robin Washington set to take on a newly created role as president and chief operating and financial officer.

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Some mid-sized software firms have already seen significant stock gains this year. Snowflake Inc. (SNOW) has climbed 21%, while Confluent is up 25%. Larger companies, such as ServiceNow Inc. (NOW) and Oracle Corp. (ORCL), could see a resurgence after experiencing pullbacks earlier in the year.

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Further upside for software stocks could come as AI-driven cost savings and efficiency improvements become more apparent. However, some investors worry that AI-powered automation might reduce the need for software seat licenses, as companies may require fewer employees to handle certain tasks.

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Walravens pointed out that software firms are adapting by incorporating consumption-based pricing models. For example, instead of charging a fixed license fee, acompany might charge per AI-assisted customer interaction. “If AI reduces the need for call center agents, software firms can charge per automated interaction instead,” he explained.

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This shift toward consumption-based pricing could create new revenue opportunities as AI adoption grows, ensuring that software companies remain a critical part of the evolving technology landscape.

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