BMO Capital on Software 2026 Outlook: 'Opportunities Amid AI Uncertainties'

BMO Capital analyst Daniel Jester believes 2026 could mark a recovery year for application and vertical software stocks.

The analyst commented: "Opportunities Amid AI Uncertainties; After a tough year for application and vertical software stocks, we believe 2026 has the potential to show some recovery, catalyzed by clarity on the growth trajectory of AI as more use cases enter production. This could take time, and entering the year we prefer vertical software generally. Our top large cap idea is Intuit ahead of what we anticipate will be a second consecutive solid tax season. Our Tier 1 outperform ideas also include Procore, ServiceTitan, and Samsara. Our top idea in the HCM group is Paylocity and in the "Office of the CFO" group is OneStream. Stocks on our shopping list include Autodesk, Bill, and Vertex.

AI / Application Debates to Persist Near-term — Software companies serving finance, HR, front office, and productivity/workflow use cases have seen some multiple compression over of the past few years as investors interrogate the durable growth opportunity with Generative AI and Agentic tools coming to market. We think the "death" of enterprise business applications is probably exaggerated, although the near-term catalyst path is murky towards a clearer bull-case for the stocks. We think 2026 shows progress deploying AI workloads in business applications and on the monetization playbook for many companies as their business models evolve. Good Opportunities in Vertical Software — The intensity of the AI debate in the vertical group is less pronounced and greater focus is on execution against strategic drivers of growth and end market health. Exiting 2025 several companies in our coverage posted solid results which we think foreshadow upside potential to estimates next year, including ServiceTitan and Samsara. Construction workflow digitalization momentum in particular looks poised to progress in the coming year as vendors release new Agentic capabilities and reduce data silos. HCM Group Waiting for Catalysts — We remain selective on the cluster as the bar to improving sentiment may take time to manifest reflecting mixed labor market data in 4Q and worries about job market implications from AI adoption on revenue models. Inside we refresh our recession analysis to show downside potential should labor market conditions moderately weaken next year. Multiples seem to already be pricing in some incremental labor market challenges in 2026, which if not manifest could create favorable conditions for the stocks. Our only outperform recommendation is Paylocity. Navigating Complexities in the "Office of the CFO" - We see myriad catalyst paths for the group in 2026 reflecting: 1) Differing positioning AI productization in a category that is expected to among the more impacted; 2) The ramp of the cloud transformation journey in cloud ERP, in particular SAP; 3) Potential impact from "AI Native" disruptors; 4) The impact of activist investors which have positions in four stocks in the group. We think OneStream has strong product market fit and a reasonable estimate trajectory. More Consolidation / PE Activity in "Back Office" Software Seems Likely in 2026 - More than 40% of our coverage this year had either a media report of potential interest in being acquired or investors publicly calling for strategic evaluations to be considered by the board. We think M&A remains active in the space as public-sector valuations - particularly application software - look less demanding than they have in some time. Inside we outline the most likely buyers (and sellers)."

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