Written by: Rita
The valuation recovery in the software sector is far from over. The software index ETF (IGV) has risen 21% since the end of June, outperforming the S&P 500 by approximately 17 percentage points. J.P. Morgan believes that infrastructure software is being driven by upward revisions to earnings forecasts, while application software is benefiting from multiple re-rating—both factors jointly fueling the sector’s rebound.
In its Q3 EPS preview report for the software industry, released on October 8, 2026, J.P. Morgan noted that infrastructure software stocks have significantly outperformed AI infrastructure stocks year-to-date. The report explicitly recommends Microsoft, ServiceNow, Cloudflare, and Snowflake, while downgrading HubSpot from Overweight to Neutral.
The article begins by examining the overall performance of the sector, analyzes the differing drivers between infrastructure software and application software, and concludes with earnings expectations for key targets.
The software index rose 20% over two months.
Of the underlying assets, 21 stocks rose in price, with gains spanning the application software and infrastructure software subsectors.
The large-cap software applications index has risen an average of 42% since the end of June. Microsoft, Salesforce, and ServiceNow have underperformed IGV year-to-date but have joined the rebound since the end of June. Investors previously overpriced concerns about AI disruption in software applications, creating a foundation for the rebound based on low expectations.
Infrastructure software has risen 78% year-to-date, with the median stock price up 34% since the end of June. AI infrastructure stocks have gained 6% year-to-date but declined 8% since the end of June. The divergence between the two groups indicates that the outperformance of infrastructure software stems from upward earnings revisions, while AI infrastructure stocks are facing pressure on valuation multiples.
Infrastructure upgraded based on improved profitability
JPMorgan believes that the excess returns from infrastructure software stem from upward earnings revisions. To support current valuations, third-quarter earnings must meet or exceed the magnitude of recent quarters' upside surprises.
Last quarter, infrastructure software companies exceeded expectations by an average of 3.6%, while application software companies exceeded expectations by an average of 1.4%. Infrastructure software companies face a higher bar for outperformance, and their valuation premiums demand stricter execution.
Despite its high valuation premium, accelerated migration is expected to drive revenue above expectations. JPMorgan anticipates that F3Q revenue guidance will be exceeded, with expectations for accelerated growth in F4Q being established simultaneously. AI-driven revenue contributions and accelerated migration are the primary upside drivers, while gross margins are expected to remain flat or decline slightly.
Cloudflare's year-over-year revenue growth is expected to accelerate to over 30%, supported by increased revenue contribution from Workers and accelerated growth in its core business, justifying a valuation premium. JPMorgan maintains a neutral rating on Cloudflare, primarily due to low visibility into Act IV monetization.
The app is revalued based on its valuation.
Previous concerns about AI disrupting overvalued software applications are being replaced by valuation recovery. J.P. Morgan believes that modest upside surprises combined with upward revisions to full-year guidance are sufficient to improve expectations for organic growth, with low expectations forming the foundation for a rebound.
Microsoft Copilot seats are expected to reach or exceed the approximately 10 million level from last quarter, with still modest monetization leverage. JPMorgan expects Azure growth to surpass the guidance range of 43% to 44%, with FY27 capital expenditure guidance at approximately $210 billion. The commitment to accelerated growth in M365 Commercial Cloud is being fulfilled, and the revenue contribution from Copilot seat growth will amplify over the next several quarters.
ServiceNow's partner dialogue points to strong growth nearing 20%, with the expected upside to current remaining performance obligations (cRPO) comparable to approximately 200 basis points from last quarter. The annual contract value (ACV) target for AI is projected to be raised further from $1.5 billion. J.P. Morgan expects cRPO growth to report in the low 20s, with organic growth approaching 19%, indicating stabilization in business growth.
Salesforce expects accelerated organic revenue growth in the third fiscal quarter (F3Q), with Agentforce’s annual recurring revenue (ARR) expanding further from $1.5 billion in the second fiscal quarter (F2Q). Partners at Dreamforce have responded positively to the simplified pricing structure and Claudeforce. Organic cRPO growth for fiscal year 2028 (FY28) is有望 to reach healthy double digits.
The entry requirements are completely different.
The degree to which results exceed expectations determines how two types of companies react in their earnings reports. Infrastructure software must significantly exceed expectations to surpass high benchmarks, while application software only needs solid fundamentals to drive positive revisions. J.P. Morgan explicitly outlines this distinction in its report.
Following its last quarter's earnings report, Twilio's stock surged strongly, raising market expectations. JPMorgan expects the revenue beat to remain positive, but remains cautious about the near-term upside potential. Based on long-term growth drivers, Twilio's price target has been raised from $260 to $335, with an Outperform rating maintained.
Datadog is expected to maintain growth above 30%, with slowing growth among its largest customers not altering the overall trend. Rising demand for observability solutions supports this growth, but valuation premiums and consensus long positions may constrain post-earnings stock performance. Dynatrace’s F2Q net new ARR is expected to be slightly below F1Q levels, with conservative full-year ARR guidance; the target price remains at $64.
HubSpot's rating has been downgraded to neutral, with the target price reduced from $268 to $240. Delayed AI monetization, extended sales cycles, and customer hesitation regarding AI ROI are pressuring mid-term growth. The restructuring will eliminate approximately 7% of the workforce, or about 660 roles, with costs of $65 million to $75 million expected in Q4 2026. J.P. Morgan is awaiting evidence of renewed new customer growth and AI credit consumption translating into incremental revenue.
JPMorgan Chase's allocation strategy is clear: choose Snowflake and Cloudflare for infrastructure software, and Microsoft and ServiceNow for application software, while placing HubSpot on hold. The software sector's recovery continues, with two distinct types of companies driven by different logic and entry barriers.
Disclaimer
This article is a compilation and interpretation by Chaoxiang Research of a third-party brokerage research report (JPMorgan, October 8, 2026), combined with publicly available market information. The ratings, price targets, earnings forecasts, and related judgments cited herein reflect the views of the brokerage’s analysts and represent only the position of their respective institution; they do not reflect the views of Chaoxiang Research nor constitute any investment advice.
The market carries risks; make decisions independently. This article should not be used as a basis for buying or selling any securities.