Outlook: Hard landing for software shares

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The Independent Online
Whoops. Shares in JBA Holdings have nearly doubled over the last year. Yesterday they gave it all back, proving yet again the obvious truism that the higher you climb the further you have to fall. The stock market doesn't take kindly to bad news from companies trading on more than 40 times forecast earnings, and rightly so, but whether it was also justified in marking down the rest of the high flying computer software and IT industry is another thing. Is this sub sector of the stock market just another speculative bubble waiting to burst, or can these heady valuations be justified?

JBA is blaming some of its problems on the widespread and well publicised difficulty in the IT market of getting suitably qualified staff at reasonable salaries. But actually the fact that JBA has ended up paying through the nose for its staff seems to be largely down to mismanagement. JBA has been pouring money into product development, but the enhanced revenue which was to pay for it failed to materialise.

The company also has a history of this sort of thing. Quite recently it caused another bout of the jitters among investors by failing to prepare accounts on time. This was a clanger never adequately explained and it may be that some of the accounting changes JBA was forced to introduce at that time are coming home to roost. Under the old methods it would simply have capitalised the extra development costs. But JBA is now under American standards and these costs must be written off as they are incurred. So JBA may be an isolated case after all.

That doesn't mean the sector isn't dangerously overvalued. Some parts of it probably are. The general rule of thumb should be that if a stock is trading in line with or below its American peers, then it's probably alright, though it will inevitably suffer the same volatility of the US high tech sector. In many cases, however, European IT stocks have begun to trade at a premium. This is particularly the case in the service part of the market, a phenomenon that tends to be justified on the grounds that the opportunities for out sourcing and the like are much better in Europe than the US because we start from so far behind.

Unfortunately, this service part of the market is also the most likely to be hit by very high rates of IT wage inflation. And can better growth opportunities in Europe really justify the fact that Sema Group trades on a higher multiple than that of Computer Sciences Corporation in the US, even though that company is now the subject of a $9bn hostile takeover bid? This seems doubtful.

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