The Value of Software

Software companies have steadily become key pillars of the digital economy, representing upwards of 12 percent of U.S. market capitalization. A simple buy-and-hold strategy of pure-play software companies over the past three decades produced annual alphas of over 7.1 percent. We document that these firms are growing at 13.9 percent annually and that both management and analysts systematically underestimate over a third of this growth. We show that these expectation errors appear to largely explain the foregoing outperformance of software companies and that management, analysts, short sellers, and other market participants ignore key performance indicators that describe these pure-play software firms and signal future growth. Together, the study underscores the value of software to the economy and how its economic impact has been significantly under-appreciated for the past two decades