Barclays maintains a Positive view on the U.S. software sector, but believes it is not yet time for broad-based excitement in Q2

Overview

This is a Barclays preview report on cyclical Q2 2026 earnings and guidance for the U.S. software sector. The core view is that the second quarter will most likely continue first-quarter trends: software spending is broadly stable, macro and employment data are improving at the margin, and FX still provides a modest revenue tailwind; however, for most SaaS companies, AI monetization remains in the early stage and is not yet enough to drive meaningful upward revisions to revenue growth and earnings expectations, so it is not yet appropriate to turn broadly excited on the sector.

Core views

The report’s most favored relative setups are concentrated in three asset groups: first, infrastructure/observability companies such as DDOG, where AI application growth could directly increase monitoring and observability demand; second, MSFT, where Azure growth has a chance to rise modestly from guided 39-40% year over year into the low-40% range, while investor expectations are relatively low; third, HCM/payroll software names such as PAYC and PCTY, where low expectations combined with potential modest beats and guidance raises create a favorable setup. By contrast, SaaS companies such as NOW and HUBS, while fundamentally solid, still have AI revenue contributions that are too small to materially change market sentiment. IBM, CRWV, WYFI, TDC, and others face company-specific or sector valuation pressure.

Analysis framework

The report uses an earnings-season preview framework, combining macro business conditions, employment and developer hiring data, FX moves, short interest, valuation tables, individual company earnings expectations, and management guidance expectations to judge the near-term risk-reward setup across different software sub-sectors.

Methodology notes

• Earnings previewBeat-and-raise setup analysis

  Earnings outperformance and guidance increases under low expectations

  The report compares market consensus expectations, prior company guidance, quarterly trends, and sentiment positioning to identify names that may modestly beat expectations and raise full-year guidance, such as PAYC and PCTY.

• Theme-drivenAI monetization and infrastructure demand mapping

  AI revenue contribution and observability demand

  The report distinguishes between AI’s early contribution to SaaS revenue and the more direct demand pull from AI workloads for infrastructure software, and therefore prefers DDOG and some MSFT-related opportunities.

• Macro and high-frequency dataBusiness conditions, employment, and developer job data

  Validation of the software demand environment

  The report cites indicators such as NFIB, ADP, Paychex, ifo, and Lightcast to observe trends in small business conditions, employment, developer job postings, and regional business activity.

• Valuation methodsTarget price multiple method

  EV/FCF, P/E, EV/EBIT, and discounted EPS

  Individual stock target prices are based on the forward free cash flow, EPS, or adjusted EBIT multiples applicable to each company, and are adjusted according to peer valuation levels and model changes.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• MSFT

  Core positive name

  Strengths

  Azure may accelerate modestly, market expectations are relatively low, greater use of its own LLM increases independence, and capital expenditure expectations are already fairly well understood.

  Weaknesses

  The report does not expect a major reversal, with catalysts likely to be more moderate.

  Comparison

  Relative to most SaaS companies, MSFT is more likely to attract attention through cloud growth and the AI infrastructure narrative.

  Risks

  If Azure fails to accelerate or capital expenditures continue to exceed expectations, the share price reaction may be pressured.

• DDOG

  AI infrastructure beneficiary

  Strengths

  AI momentum drives observability demand, and the report raises the target price while maintaining OW.

  Weaknesses

  Valuation requirements are high, requiring sustained delivery of growth acceleration.

  Comparison

  Compared with SaaS names such as NOW and HUBS, DDOG has a more direct transmission path from AI demand.

  Risks

  If AI-related demand does not translate into revenue or guidance, the valuation premium may retrace.

• NOW / HUBS

  SaaS representatives that are solid but unlikely to drive a major reversal

  Strengths

  Core growth drivers remain intact, and quarterly numbers are expected to be solid.

  Weaknesses

  AI revenue contribution remains small and may be insufficient in the near term to trigger major upward revisions.

  Comparison

  Compared with last quarter’s SNOW-style acceleration story, NOW and HUBS have less obvious catalysts for estimate upgrades.

  Risks

  If results merely meet expectations, market sentiment may remain subdued.

• PAYC / PCTY

  Constructive setup in HCM/payroll software

  Strengths

  Market expectations are low, with room for modest revenue and EBITDA beats as well as guidance increases.

  Weaknesses

  Growth remains in a low-growth or slowing phase, so the magnitude of improvement may be limited.

  Comparison

  Compared with higher-valuation SaaS, payroll software relies more on execution improvement under low expectations.

  Risks

  If employment and customer spending do not continue to improve, room for beat-and-raise may narrow.

• IBM

  An OW name with questions

  Strengths

  The rating remains OW, and its long-term cash flow base is still recognized.

  Weaknesses

  The recent profit warning was weaker than expected, and the target price was cut sharply.

  Comparison

  Compared with MSFT, IBM is more vulnerable to skepticism around AI and capital expenditure-related narratives.

  Risks

  If the weakness mainly reflects operating expense or demand issues rather than capital expenditure timing, valuation may remain under pressure.

• CRWV / WYFI

  AI infrastructure but with higher volatility

  Strengths

  The AI infrastructure theme still has support, and WYFI’s target price was raised modestly.

  Weaknesses

  CRWV’s target price was cut due to lower peer valuations, while WYFI’s results could be more binary.

  Comparison

  Compared with DDOG, hard-asset AI infrastructure and capex pathways bring greater uncertainty.

  Risks

  If profit ramp, capital expenditures, pipeline buildout, and capacity progress fall short of expectations, downside risk to the share price could be significant.

• APPN

  Low-sentiment rebound candidate

  Strengths

  Cloud subscription revenue expectations appear conservative, and AI usage plus improved sales efficiency may support a modest beat.

  Weaknesses

  The report is still waiting for stronger confidence in renewed revenue acceleration and margin expansion.

  Comparison

  Compared with high-quality OW names, APPN is more of a tactical rebound opportunity driven by low sentiment and high short interest.

  Risks

  High short interest and insufficient fundamental sustainability may amplify volatility.

Key data

• Sector viewPositive, unchangedThe cover shows the U.S. Software sector view as POSITIVE and Unchanged.
• MSFT target price$545, rated OWThe report believes Azure growth may come in modestly above the guided 39-40% year-over-year range, entering the low-40% area.
• DDOG target price$290, raised from $260The rating remains OW, and the target price increase reflects expectations for a stronger near-term growth algorithm.
• CRWV target price$90, cut from $120The rating remains EW, with the multiple reduced to reflect lower AI infrastructure peer valuation levels.
• IBM target price$288, cut from $350The rating remains OW, but the target price is reduced to reflect a weaker-than-expected preannouncement and lower peer valuations.
• Median short interest in the software coverage universe10.5%, versus 8.8% on April 15The report says median short interest has risen by about 180 basis points since April 15.
• Year-over-year growth in software engineering jobs+32% in June 2026Lightcast data show stronger year-over-year growth in total software engineering jobs by the end of Q2.
• FX impactModest revenue tailwindAlthough the U.S. dollar rebounded at the end of Q2, the quarterly average was still weaker year over year, benefiting reported revenue for software companies with higher international exposure.
• Small business employmentImproved for four consecutive monthsThe Paychex small business employment index showed its first four consecutive monthly increases since November 2020 as of June.

Impact & implications

For investors, the implication of the report is not to chase the entire software sector higher, but to distinguish during earnings season whether AI stories are starting to show up in revenue and guidance, and whether current expectations are low enough. Infrastructure software, Azure-related large-cap names, and payroll/HCM software offer more attractive near-term risk-reward; traditional SaaS names may still be insufficient to trigger a market rerating if they only deliver solid quarters.

Risks

• If progress in AI monetization continues to fail to show up in revenue, guidance, and estimate revisions, software sector valuations may lack upside momentum.
• Earnings-season volatility may intensify, especially for high-valuation, heavily shorted, or already-improving expectation names.
• IBM’s profit warning suggests AI and capital expenditures may be crowding out other IT spending; if the impact spreads from capex to opex, software demand risk will rise.
• Declining AI infrastructure peer valuations may continue to pressure target prices and valuation multiples for related names such as CRWV and WYFI.
• If FX tailwinds reverse because the U.S. dollar continues to strengthen, companies with higher international revenue exposure may face pressure on reported revenue.
• If improvements in employment and small business data do not continue, the beat-and-raise logic for HCM/payroll software may weaken.

What to watch

• Whether MSFT Azure’s actual year-over-year growth enters the low-40% range, and management’s commentary on its own LLM and capital expenditures.
• Whether DDOG can demonstrate observability demand driven by AI workloads and push faster revenue or guidance growth.
• Whether AI products at SaaS companies such as NOW and HUBS begin to affect bookings, revenue, or management guidance.
• Whether PAYC and PCTY deliver modest revenue/EBITDA beats and provide full-year guidance better than low expectations.
• The pace of capital expenditures, capacity ramp, pipeline buildout, and profitability improvement at AI infrastructure companies such as CRWV and WYFI.
• The risk of a squeeze or decline after earnings for highly shorted names such as WYFI, CRWV, MNDY, APPN, and KVYO.
• Whether macro business conditions, ADP/Paychex employment data, Lightcast developer job data, and the U.S. dollar trend continue to support software demand.