The software sector has been putting on a good show of late. And a survey of 10 key companies in the sector shows analysts anticipate collective sales of US$96.7 billion in fiscal 2007, representing a year-over-year increase of 18%. This is on top of 19% gains in each of the previous two fiscal years.

But raw growth alone doesn’t tell the story. If there’s a trick to investing in software companies, it lies in anticipating the pace of revenue from new product cycles. Many of the largest software firms are currently riding such waves, and none more so than Microsoft Corp. of Redmond, Wash., which is in the middle of the most extensive lineup of product launches in its history.

Its Xbox 360 gaming console and new business servers, all introduced last year, have helped reinvigorate Microsoft’s revenue, which — after a slowdown in the fiscal year ended June 30, 2005 — is again growing at a double-digit pace.

Analysts believe the software giant will be able to sustain this momentum, thanks to the imminent launches of three products that account for more than 60% of the company’s total revenue:

> Windows Vista, the company’s new operating system, is being released to business customers in November and to the general public in January.

> Office 12, Microsoft’s office software suite — which contains Word, Excel, PowerPoint and other productivity programs — is scheduled for introduction early in 2007.

> Exchange 12, an upgraded e-mail program, will be launched sometime before July 2007.

The early consensus is revenue from the new products will have relatively little impact in fiscal 2007. This is because many customers like to wait for the inevitable bugs to be worked out. Also, buyers tend to wait until they need a new computer; then the new software comes already installed.

Even so, the short-term outlook for Microsoft is good. The consensus among analysts surveyed by Reuters is Microsoft’s sales in fiscal 2007, paced by its entertainment and devices unit, will jump 13% to US$50.3 billion. Revenue is expected to jump a further 11% in fiscal 2008, when sales of the new versions of Vista, Office and Exchange gain momentum.

In fact, three out of four analysts who cover the firm rate Microsoft a “buy,” according to Bloomberg LP.

“Investment in new products will continue at a torrid pace,” writes Peter Misek, an analyst with Canaccord Adams Inc. , a subsidiary of Vancouver-based Canaccord Capital Inc. , in his Oct. 27 research note. “But the company’s top line will be a catalyst for share price appreciation.”

Misek rates Microsoft a “buy,” with a target price of US$30 a share. (It was trading around US$28.35 a share in late October.) Although that represents a relatively slim 6% gain, Microsoft also offers investors an annual dividend of US40¢ a share, for a yield of 1.4%.

There is another reason inves-tors should keep careful watch on new products at Microsoft — not just for their impact on Microsoft sales but also for how they will affect software firms that compete in each of those niches.

Three software firms appear relatively immune to the Microsoft juggernaut so far. Google Inc., BEA Systems Inc. and Oracle Corp. — all based in California — are expected to post stronger revenue growth than Microsoft in their fiscal 2007 years. Analysts favour Google and Oracle, but that’s because BEA Systems’ share price has already jumped 75.5% so far this year — far faster than other software firms surveyed.

Google, which generates advertising revenue through its wildly popular search engine, has consistently exceeded consensus projections by analysts, 83% of whom rate it a “buy.” Google’s breakneck growth — a 43% rise in revenue to US$15.1 billion, along with a 33% jump in earnings to US$13.75 a share forecast for the fiscal year ended Dec. 31, 2006 — has given the firm some lofty multiples.

Paul Keung, an analyst at Toronto-based CIBC World Markets Inc. , explains the assumptions underlying his share price target of US$525 in a research note dated Oct. 20. The target, he writes, assumes Google will trade at 30 to 35 times CIBC’s earnings estimate of US$17 a share in 2008.

“The market will continue to apply greater than a 30 to 40 times multiple as long as Google’s growth remains robust and the bias toward estimate revisions remains upward,” he notes in the report.

@page_break@The danger, of course, is the instant Google disappoints, those multiples will quickly come down. And because Google doesn’t offer guidance to analysts, investors may get little warning.

Oracle and BEA Systems both show signs of putting disappointing years behind them. Oracle reported a revenue surge of 30% year-over-year in its first quarter ended Aug. 31 — a result that company president Charles Phillips attributes, in part, to Oracle’s success in stealing market share from German rival SAP AG. Analysts from New York-based UBS Securities LLC note in their October software industry outlook that Oracle is also finally getting solid results from its recently acquired Siebel and PeopleSoft units.

BEA Systems, which makes a technology platform that corporations use to create and run software applications, is expected to report revenue growth of 28% in its fiscal year ended Jan. 31, 2007. That’s a huge improvement over its 6.7% sales gain two years earlier. The explanation has a lot to do with the firm’s successful introduction of AquaLogic, the latest of three components that make up BEA Systems’ technology platform. Sales of AquaLogic products make up 20% of the company’s licence revenue, up from a standing start a little more than a year ago.

Todd Raker, an analyst with Frankfurt-based Deutsche Bank Securities Inc. , rates BEA Systems as a “long-term growth story.” But his Sept. 19 research note — following the company’s analyst day — carries a price target of US$16.50 a share. That was written when BEA Systems’ share price was US$14.66; by late October, it had already reached US$16.50, suggesting the stock is fully valued.

Microsoft’s new products pose a significant longer-term challenge for other firms on the list. For example, last year’s introduction of Microsoft OneCare — a security service for personal computers — could hurt security software giant Symantec Corp. of California, according to Kevin Buttigieg, an analyst with A.G. Edwards & Sons Inc. of St. Louis. Buttigieg, who rates Symantec a “hold” in his Oct. 26 note, concludes the firm did well in its most recent quarter ended Sept. 29, posting 12% growth year-over-year in its consumer software unit. But, he adds, Symantec “is likely to see competition increase over time as Microsoft broadens the feature set of OneCare.”

Microsoft could also challenge Paris-based Business Objects SA and Ottawa-based Cognos Inc. — the leading developers of a class of products known as “business intelligence” software. BI products allow corporate finance managers to measure how well their companies are faring on a wide variety of metrics, such as sales employees’ results by product or region. BI systems are large and complicated but, once installed, customers tend to stick with them.

Nevertheless, the core BI market is slowing, just as Microsoft has been adding more features to its Excel spreadsheet analysis programs, which are designed to satisfy the needs of less information-intensive managers.

Licence sales of Business Objects’ BI software dropped 5% year-over-year in its third quarter ended Sept. 30, while licence revenue at Cognos fell 1% in its second quarter ended Aug. 31. The two firms have been trying to make up lost ground by pumping up revenue from services and introducing new performance-management software, including products that evaluate quality of data or help manage human resources and customer relations.

In the short term, however, neither Business Objects nor Cognos is expected to deliver robust growth. The Reuters consensus puts revenue growth at slightly less than 10% next year for both firms. Even so, the companies have their champions among a small majority of the analysts who cover them.

Deutsche Bank AG analyst Tom Ernst Jr. rates Cognos a “buy” in a Oct. 12 note. Ernst cites Cognos CEO Rob Ashe’s determination to achieve double-digit licence growth, as well as potential upside from new software applications. Ernst’s target price is US$41 a share, an 11% gain from the date of the report.

Business Objects rates a “speculative buy” from Misek in his note, with a share price target of US$40. The shares were then trading at US$34.12 a share, but jumped to US$37.48 the following day. Investors aren’t likely to find Business Objects a compelling play, given its risks.

One software firm that could offer a pleasant surprise is Ottawa-based Corel Corp. , ironically the firm most badly beaten up by Microsoft in the past. Its share price on Oct. 26 — US$12.46 — was only eight times its projected earnings per share for fiscal 2007; it remains well below its US$16 initial public offering price earlier this year. Corel also beat consensus estimates for both sales and earnings in its third quarter ended Aug. 31. IE