Software stock premiums have fallen to their lowest levels since the financial crisis. Goldman Sachs: Don't rush, they're not done falling yet!

Against the backdrop of rapidly rising AI-driven disruption beyond expectations, the global software and IT services sectors are undergoing a profound revaluation reset.

According to Wind Chasing Trading Desk, Goldman Sachs analyst Sharon Bell's team highlighted in their latest strategy report that the software sector's valuation premium relative to the broader market has fallen to its lowest level since the financial crisis. On the surface, it seems the market has already reacted quite aggressively to the “AI shock.”

However, Goldman Sachs stressed that the current decline is more like “valuation compression” rather than a complete cyclical purge. Historical experience shows that high-margin, asset-light industries such as software tend to see stock prices genuinely stabilize only after earnings expectations have been revised down. As consensus earnings remain elevated, the current adjustment may not yet be fully priced in.

AI-driven expectations trigger sharp rotation; software becomes “first in line for selling”

Despite Europe's stock markets rising about 4% year-to-date, a significant structural rotation is taking place beneath the indices.

With the fast evolution of AI automation tools and large model capabilities, the market is systematically re-evaluating business models reliant on software, data aggregation, and information distribution. Sectors including software, data services, information providers, publishers, alternative asset managers, and gaming stocks have generally seen double-digit declines since the start of the year.

Goldman Sachs statistics show that the European software sector has fallen about 16% year-to-date, while its digital economy thematic basket is down about 10%, clearly underperforming the broader European market supported by financials, resources, utilities, and industrials.

In Goldman’s view, Anthropic’s release of next-generation large models and automation tools was merely a “catalyst.” The real driving factor is: the market is beginning to question whether the high profit margins that the software industry has built over the past decade-plus can persist in an era of widespread AI adoption.

Valuation premium collapses rapidly, now back to financial crisis levels

On the valuation front, the repricing of the software sector is already quite significant.

Goldman Sachs data shows that European software & IT services companies currently trade at a 12-month forward price-earnings ratio of about 16.8x, with a premium to the broader market of just 9%. This is close to the lows during the 2009 financial crisis (the lowest back then was about 8%). In contrast, one year ago, the sector’s valuation premium was still over 70%.

In the broader digital economy space, the forward P/E has compressed from 18.7x at the start of 2025 to 13.7x now, putting it at the bottom range of valuations over the past two decades.

From a static perspective of matching valuation to growth, software stocks seemingly have “corrected to a reasonable range”: the current valuation implies revenue growth assumptions of only 4%–5%, roughly in line with nominal GDP, while analysts’ medium- to long-term revenue growth expectations for the software industry remain close to 9%.

The issue is not current earnings, but the “sustainability” of profit margins

Goldman Sachs believes that the real market worry is not about a near-term earnings collapse, but whether the profit structure faces systemic compression over the medium and long term.

A seemingly “positive signal” provides a key reason for Goldman’s caution: analysts’ EPS estimates for the software sector have barely been revised down.

Data shows that over the past decade, net profit margins in the software & IT services sector have continually risen, reaching about twice the average level of other European non-financial sectors, with most of the expansion occurring in the most recent full cycle.

Goldman Sachs points out that high profit margins mean both a moat and a higher risk of disruption. When AI tools sharply lower development, maintenance, and replacement costs, pricing power and profit space will be the first areas to be eroded.

The report compares the software industry to the mobile communications industry: the latter has long been in a highly competitive, homogenized environment with continually falling prices, while the software sector over the past decade has shifted from “deflationary forces” to a “mild source of inflation,” making it more vulnerable when structural shocks occur.

History shows: valuation drops first, earnings adjust later, then stock prices truly stabilize

Even at current valuation levels, Goldman Sachs still doesn't believe risks have been fully priced in.

The report reviews the history of the software sector and other industries disrupted by technology (such as newspapers in the 2000s and tobacco in the 1990s), finding that a sustainable rebound in stock prices often occurs only after profit expectations have bottomed out and begun to recover, not just when valuations first decline.

From this perspective, the current software sector adjustment looks more like the first half of a revaluation process:

Profit margins are still at cyclical highsConsensus EPS has yet to reflect potential competitive shocksThe market is mainly digesting uncertainty via valuation compression

Goldman Sachs thus judges that the current decline is more “preemptive pricing” rather than a complete clearing process.

Although remaining cautious on the software sector overall, Goldman does not deny the long-term allocation value of technology stocks. At a strategy level, Goldman emphasizes that in a low-correlation environment, individual stocks and sub-sectors will continue to dominate market performance. Index-level returns may be limited, but companies with deep moats and pricing power may still outperform.

Overall, the signal from Goldman Sachs is quite clear: software valuations have returned to historical lows, but until earnings expectations are fully repriced, the real bottom may still require patience.

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The above excellent content is from Wind Chasing Trading Desk.

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