Stocks driving the artificial-intelligence race have made a comeback. The Roundhill Magnificent Seven ETF MAGS moved back into positive territory last week after recovering everything it lost this year. But as investors pile back into the big names, they may be missing out on where the real strides in AI are expected to take place next, which is in software stocks.
According to BlackRock’s Tony Kim, head of fundamental equities for the global technology team, the next big stage in AI’s development will be the exploding use cases that come from the software industry, which is expected to permeate every sector of society. Simply put, software companies are building the bridge between AI and its deployment by businesses and everyday people.
This year, MarketWatch interviewed Kim as he was wrapping up BlackRock’s annual tech tour that lasted five days and included meetings with about 25 technology companies across Silicon Valley and San Francisco. Kim’s overall insight as he reflected on the week is that the development of AI is powering full steam ahead. Despite concerns over the domestic economy, geopolitical tensions, or the development of cheaper AI models like the one that came from DeepSeek, there has been no abatement on the part of U.S. companies developing AI, he said. And the software companies that are deploying AI are well-positioned to be the next beneficiaries of that expansion.
As for investors worried about whether there will be enough demand for AI to justify the optimism that has driven up Nvidia Corp.’s NVDA stock, or the hefty capital expenditures hyperscalers are committing to develop AI infrastructure, Kim’s simple response is to look around and ask some very basic questions, such as whether AI has transformed all the areas and sectors it can. In other words, does everyone have an AI assistant helping them in their daily lives? Are employees across companies now fully using AI agents in their workflows? And is physical AI in the form of autonomous vehicles and robotics operating at full scale? The answer to all of those questions is no, he said, meaning that AI is just getting started.
Furthermore, he added that AI’s capabilities are improving rapidly, suggesting that there will be more use cases and efficiencies that have yet to be discovered. Over time, the costs to develop and run AI are expected to decrease.
As for Nvidia, the company sits at the absolute epicenter of AI’s development, especially because there will be a big need for AI factories both domestically and globally to power all these applications, Kim said. During Nvidia’s fiscal first-quarter earnings call, Chief Executive Jensen Huang said that one of the main growth areas for the company was the need for AI factories, which create and deploy AI. Huang added that demand is helping cushion revenue losses from China following the U.S. government’s export restrictions on its H20 product.
And while Kim was positive about Nvidia’s prospects, he was even more excited about the opportunities that could be found in the software sector, as those companies integrate AI into their products.
The case for software stocks in the era of AI development
Within the software sector, there are two main categories — enterprise and consumer-facing applications — and investors should pay attention to both, Kim noted. Consumer-facing providers include tax-software provider Intuit Inc. INTU and language educator Duolingo Inc. DUOL. Enterprise-based software companies include Salesforce Inc. CRM, which provides customer-relationship-management offerings, and Autodesk Inc. ADSK, which makes design technology.
According to BlackRock’s fundamental equities technology team, there are a few key reasons to focus on software companies at this early stage in the AI boom. For one, these companies have an opportunity to increase their competitive advantage as they acquire or build proprietary AI systems and maintain unique data sets. In other words, companies can differentiate from rivals by building unique AI systems using data they have.
The software sector is also ripe with emerging AI technologies that can serve every industry. At the center of booming AI demand will be agentic AI, which can make decisions and take action. These tools can be built to manage and improve inventory, help developers code, assist doctors with patient care and even help design architecture.
Additionally, software companies can more easily keep up with the AI boom because they can rapidly scale to meet demand, since most rely on central cloud storage rather than expensive hardware. This also means they can grow customer bases without big increases to their operating costs. For this reason, software companies tend to have higher profit margins, with the median subscription profit margin being about 80%, according to BlackRock’s fundamental equities technology team.
Software companies also tend to have recurring revenue because most of them run subscription-based businesses where payments are made monthly or annually. This reduces investment risk because there’s more predictability when forecasting the company’s future cash flows. Furthermore, software companies that operate in niche industries and deploy AI-enhanced solutions are even better investments because it’s more difficult for their customers to switch to a different provider, since it’s expensive to change a company’s entire system, according to BlackRock’s fundamental equities technology team. Therefore, these software companies tend to see less customer turnover, making their future cash flows even more predictable.
Overall, investors should focus on companies that show sustainable growth and strong unit economics, meaning that each product or service sold has a good profit margin.