Written by: Rita

Guide to Trends

In the past two years, the software sector has underperformed the Nasdaq by 40% and the S&P 500 by 30%. The expectations of AI reshaping industries continue to ferment, and the market's valuation of software stocks is pessimistic, with funds only considering the ongoing value and neglecting the long-term growth potential.

Morgan Stanley released a 170-page in-depth report on the software industry, judging that the current pessimistic expectations are overvalued, maintaining an "attractive" rating for the software sector.

The report builds a new analytical framework; the moat measures the current competitive base of the business, while the journey assesses long-term growth potential. Companies that possess both advantages have higher configuration value. Morgan Stanley selected eight high-conviction overweight targets: Microsoft, Palo Alto Networks, CrowdStrike, Shopify, Cloudflare, ServiceNow, Datadog, and Snowflake. Adobe and Workday were downgraded to underweight, as institutions expect the commercialization timeline of AI for these two companies to be longer than market expectations.

The value focus of AI should be on the workflow layer. This is the core conclusion of this report.

Attack and Defense Dual-Dimensional Framework: Identifying Core Competencies of Software Companies in the AI Era

This analytical framework is logically clear and can effectively distinguish the growth prospects of companies.

The moat represents short-term defensive capabilities, with assessment dimensions including whether the business is mission-critical, whether it serves as a core record system, customer switching costs, proprietary data reserves, and industry accumulation. High-quality targets have prominent customer stickiness; their systems are deeply integrated into business operations, and service interruptions will directly affect daily operations.

The journey represents long-term growth prospects, with evaluation dimensions covering modern product architecture, clear and feasible AI development pathways, potential for pricing models to transition to usage-based billing, and the capability for establishing intelligent ecosystems.

Historically, market investment decisions have mostly emphasized the moat; a single existing barrier is inadequate to support long-term valuations. In the context of the AI industry transformation, only companies with deep barriers that can continuously iterate will have sustained valuation realization. Among the 81 targets covered by institutions, only five meet both criteria: Microsoft, Palo Alto Networks, CrowdStrike, Shopify, and ServiceNow. These companies have a solid operational foundation and also possess long-term growth potential.

Analysis of Core Quality Targets: Clarifying the Growth Logic of High-Conviction Assets

Morgan Stanley identifies eight companies as the highest conviction overweight targets, each with distinctly different growth logic.

Microsoft possesses both a solid moat and growth potential. Morgan Stanley determines that the growth bottleneck for Azure stems from supply constraints, while market demand remains strong. The willingness to deploy Copilot on the enterprise side continues to rise, with 88% of CIOs planning to implement M365 Copilot in the next 12 months, up from 72% last year. The market underestimates Microsoft's AI commercialization potential; revenue is not just from model API sales but also includes databases, storage, development tools, and the complete ecosystem of Azure AI Foundry. The company has a FY28 price-to-earnings ratio of 16 times, corresponding to a sustainable EPS growth rate of over 20%, which makes its valuation attractive.

Palo Alto Networks and CrowdStrike are the two giants in cybersecurity. AI has spawned new security threats, leading to a sustained increase in protective demands, and companies are simultaneously advancing supplier integration, leaning towards purchasing integrated platform services. Palo Alto's platform strategy is being steadily implemented, with a net retention rate for platform customers of about 120%, significantly higher than that of regular customers. CrowdStrike's Falcon Flex ARR has surpassed $1.9 billion, with a year-on-year growth rate of 99%.

Shopify is the only e-commerce SaaS vendor on the list. With the Sidekick AI website building tool, the barrier to entrepreneurship continues to decrease, extending its service group from established merchants to individual entrepreneurs. The company's FY27 free cash flow corresponds to a valuation of 46 times, aligning with a 25% compound revenue growth rate and a 30% compound free cash flow growth rate, suggesting that the valuation has not fully reflected the value of business upgrades.

Snowflake and Datadog are positioned in the infrastructure sector. Snowflake, as a data cloud platform, meets the demand for data construction in corporate AI transformation. Datadog focuses on observable business, which matches the operational needs following large-scale deployment of intelligent agents; vast amounts of intelligent agents continuously generate logs and tracking data, driving stable growth in operational needs.

Underlying Logic of the Industry: Workflows as the Core Carrier of AI Value

This is the fundamental judgment of the entire report.

Morgan Stanley cites findings from a joint study by Harvard Business School and BCG, showing a serrated frontier. The research set up a controlled experiment, assigning business analysis tasks to consulting teams, one equipped with AI tools and the other without. The experiment showed that the team equipped with AI tools had a 19 percentage-point decrease in conclusion correctness. AI excels in text creation, brainstorming, and structured writing, but in complex business scenarios requiring cross-validation of information and multidimensional evaluation, it is prone to deviations, and users may blindly follow the output.

The capabilities of frontier models continue to iterate, but the progress toward real-world applications in complex enterprise scenarios has plateaued. The models adapt well to standardized tasks such as code development and general content creation where data is abundant and results are easy to verify. Enterprise workflow scenarios exhibit significant differences; processes lack standardized documentation, evaluation criteria tend to be subjective, and there are no unified standard answers.

Workflows carry the core of AI value realization. Proprietary data, access control, audit traces, business process systems, and industry knowledge together form the value system. Companies that hold the dominant power in workflows can continuously grasp pricing initiatives.

This logic supports institutions' optimism towards Shopify, ServiceNow, Datadog, and Snowflake, as these four companies control critical nodes in industry workflows.

Industry Cycle Rotation: Infrastructure Leads to Realization, Applications Await a Turning Point

Morgan Stanley reviews the development path of cloud computing, noting that the industry has gone through widespread adoption of SaaS, pilot cloud solutions, architectural standardization, and the self-development application phase.

The AI industry has now entered the self-build stage. Infrastructure software is the first to reap the incremental demand, with new orders for data and operations firms like Snowflake, Datadog, and MongoDB continuously improving. Cybersecurity follows closely, with AI creating new types of security risks and platform integration rhythms accelerating.

The performance realization rhythm in application software is relatively slow. ServiceNow is closer to an industry turning point, while Shopify's AI commercialization process continues to advance. Salesforce, Workday, and Intuit require longer adjustment periods, as companies face challenges such as pricing model transitions, competition from AI-native vendors, and pressure on profit margins.

Within the application sector, Adobe and Workday have received underweight ratings. Adobe is facing the diversion of lightweight customers to various AI tools, compounded by pressures from executive transitions and business model transformations. Workday's AI commercialization progress is slow, as HR and financial processes have high compliance requirements, and customers are unlikely to switch core systems based solely on AI capabilities.

Perspective on Trends

The core signal of this report is that the investment logic in the software industry is undergoing a systematic shift. The market previously favored highly valued, high-growth star targets, while the current phase favors hybrid assets with balanced strengths and weaknesses, providing greater certainty. This represents a systematic revaluation of industry valuation frameworks, which goes beyond simple emotional corrections in the sector.

The common characteristic of the eight high-conviction targets is that they stand at the intermediary layer of AI realization. Leveraging their accumulated customer, data, and process advantages, they become essential nodes in corporate AI transformation, and their value will continue to be released as AI applications deepen.

Industry differentiation will further intensify. Companies with deep barriers and continuous evolution capabilities will be able to maintain and expand their advantages in this round of industry reshuffling. Companies excelling in a single dimension will gradually weaken in their long-term competitiveness.

The low allocation conclusions for Adobe and Workday convey an important investment insight. In the AI era, time costs are also a core valuation variable. Market expectations for growth, if not realized as actual performance in a timely manner, will deplete significant returns. The evaluation criteria for quality assets must consider both long-term growth potential and the rhythm of performance realization.

Disclaimer

This article is a summary and interpretation of a third-party brokerage report (Morgan Stanley, July 21, 2026) by Trend Guide Research. The ratings, target prices, profit forecasts, and related judgments cited in the text are the opinions of the brokerage's analysts and only represent the position of their affiliated institution, not the viewpoint of Trend Guide Research, and do not constitute any investment advice. The market carries risks, and decisions should be made independently. This article should not be used as the basis for buying or selling any securities.