Strong Revenue Growth Signals Recovery
The software sector has faced significant headwinds in 2025, declining 24% year-to-date compared to the S&P 500’s more modest 7.5% drop. The sector sits 34% below its mid-September 2025 peak, primarily driven by concerns over AI disruption and decelerating revenue growth. This downturn represents the fourth-largest decline in the sector’s history, trailing only the dot-com bubble crash (-63%), the Global Financial Crisis (-50%), and the post-COVID technology selloff (-46%).
However, beneath the surface volatility, fundamental performance indicators suggest the sector’s underlying strength remains intact. Software growth has demonstrated notable reacceleration since mid-2023, with last twelve months total revenue climbing 15% year-over-year in the fourth quarter of 2025. This marks the highest growth rate since early 2023 and represents a significant 4 percentage point improvement from the 11% recorded a year earlier, when excluding cloud providers from the analysis.
Large-Cap Outperformance Drives Sector Dynamics
A clear bifurcation has emerged within the software landscape, with large-cap Software-as-a-Service (SaaS) companies significantly outperforming their smaller counterparts. Large-cap firms are demonstrating a 7 percentage point advantage over smaller peers amid ongoing AI disruption concerns. These established players recorded revenue growth of 17% year-over-year in the fourth quarter of 2025, compared to 12% in the same period of 2024, with expectations for this 17% growth rate to continue into the first quarter of 2026.
Strategic AI Positioning Supports Investment Case
The analyst maintains an overweight rating on the software sector, citing strategic positioning around artificial intelligence adoption. Large-cap software companies are prioritising AI usage growth over aggressive upselling of premium packages, demonstrating a measured approach to monetisation. Clear revenue generation pathways have emerged through premium stock keeping units (SKUs) and generative credit consumption via usage-based pricing models.
This strategic shift away from traditional seat-based subscription models provides crucial protection against revenue erosion from industry-wide layoffs. The current valuation environment presents an attractive entry point, with the EV/Sales ratio for large-cap SaaS companies trading below the negative one standard deviation level of 9.4, despite rising software revenue and net income performance.
Frequently Asked Questions
Q: How has the software sector performed compared to broader markets in 2025?
A: The software sector has declined 24% year-to-date, significantly underperforming the S&P 500’s 7.5% drop, and sits 34% below its mid-September 2025 peak.
Q: What are the main factors driving the software sector decline?
A: The primary drivers are AI disruption concerns and slowing revenue growth, making this the fourth-largest sector decline historically.
Q: How does current revenue growth compare to previous periods?
A: Software revenue growth has reaccelerated to 15% year-over-year in Q4 2025, the highest since early 2023 and 4 percentage points above the 11% recorded a year ago.
Q: Are large-cap and small-cap software companies performing similarly?
A: No, large-cap SaaS companies are outperforming smaller peers by 7 percentage points, with large-cap revenue up 17% year-over-year versus 12% in the prior year.
Q: What is the analyst’s recommendation on the software sector?
A: The analyst maintains an overweight rating on the software sector despite recent volatility.
Q: How are software companies adapting their AI strategies?
A: Large-cap companies are prioritising AI usage growth over aggressive premium package upselling, focusing on clear monetisation routes through premium SKUs and usage-based pricing.
Q: What protection do companies have against industry layoffs?
A: The shift from seat-based subscriptions to usage-based pricing models helps protect revenue from industry-wide employment reductions.
Q: How attractive are current valuations?
A: The EV/Sales ratio for large-cap SaaS is trading below the negative 1 standard deviation level of 9.4, despite rising revenue and net income, suggesting attractive valuations.
This article has been auto-generated using PhillipGPT. It is based on a report by a Phillip Securities Research analyst.
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