The previous downturn in global markets coincided with prosperous times for Softcat, as the pandemic fueled a surge in spending by companies equipping employees for remote work, leading to increased sales for the IT equipment and software reseller.

Unlike the previous episode, the current market turmoil is not expected to bring similar benefits to Softcat. Diminished corporate confidence has begun to overshadow the valuation of this FTSE 250 company.

Currently, Softcat’s shares are trading at 21 times forward earnings, down from a pandemic peak of 44, when businesses rushed to bolster their corporate IT budgets. However, this figure is also lower than the ten-year average of 25.

Founded in the early 1990s as a PC vendor in High Wycombe, Softcat has since expanded its operations to sell billions of pounds worth of software and hardware services. The company operates across both private and public sectors, and its stock performance has been buoyed by growing demands for technological advancements.

The potential for a recession triggered by tariffs poses a risk to Softcat’s growth this year. In its interim report released earlier this month, the company raised its profit growth outlook for the year to “low double-digit” levels, which is an improvement over previous projections of a “high single-digit” increase.

For the first six months of its financial year, ending in January, Softcat reported a 17 percent increase in revenue to £546 million, with pre-tax profits rising 12 percent year-over-year to £76.7 million. Analysts expect this growth to continue, forecasting an annual profit of £177 million.

The gross invoiced income (GII), which reflects total income billed to customers, grew by nearly 20 percent to £1.5 billion in the first half of this year. This increase was driven by recovering hardware sales and intensified demand from data centers, despite businesses delaying upgrades of their existing hardware. The shift to cloud-based solutions, necessitated by the need for enhanced computing power to integrate AI, has also bolstered corporate expenditures.

Anticipation of a new cycle of device refreshes—driven by AI-integrated PCs and the upcoming Windows 11 upgrade, as support for Windows 10 ends in October—could further stimulate spending. Microsoft remains Softcat’s key partner, accounting for roughly 25 percent of GII and about 15 percent of gross profit for 2024.

Softcat has captured a larger share of corporate IT budgets, with average gross profit per customer increasing by nearly 11 percent to just above £43,000. The UK addressable market is estimated at £60 billion, with resellers and distributors holding around half of that market share. According to estimates from Panmure Liberum, Softcat’s market share has grown from about 3 percent in 2019 to 5 percent now, indicating considerable potential for future growth.

Valued at 21 times forward earnings, Softcat is regarded as one of the pricier technology stocks in London, outperforming peers like Bytes Technology Group at 18 times and Computacenter at 12 times. However, several factors justify this elevated valuation, including earnings growth at a compound annual rate of 14 percent over the last decade and an attractive cash conversion rate of 102 percent.

Market analysts predict another increase in dividends, with a consensus estimate of 49.37p per share, translating to a promising potential yield of 3.4 percent based on current share prices, and an estimated yield of 3.7 percent based on dividends projected for the following year.

Softcat’s headcount growth has slowed to 6 percent over the last six months, less than half the pace of the previous year, reflecting a challenging market environment that could help stabilize margins.

Long-term investors have benefited from compounding, enjoying a total return of 417 percent over the last decade, contrasted with nearly 3 percent for the FTSE 250 and 19 percent for the FTSE All-Share during the same timeframe.

However, the substantial forward earnings multiple indicates that Softcat bears high growth expectations, potentially rendering it susceptible to shifts in investor sentiment towards more conservative strategies.

Recommendation: Hold – The current valuation is indicative of an increasingly challenging trading climate.