Oracle

(ORCL) - Get Report

is skating dangerously close to slipping below $8;

Microsoft

(MSFT) - Get Report

dropped into the $40s last week. The downward spiral of software stocks, which lost most of their gains from Wednesday's rally, has prompted some analysts to say the sector has finally reached the bottom.

But don't get too excited yet. There's also considerable competing evidence that software stocks remain fully valued, especially given the uncertainty about when the economy will pick up.

Just look at the multiples.

PeopleSoft

(PSFT)

, for instance, is trading at 28 times forward earnings, compared with a 10-year low of 22 in 1999.

Siebel

(SEBL)

is trading at 33 times earnings, compared with a low of 19 in 2001.

SAP

(SAP) - Get Report

, trading at 31 times earnings, is down only 27% from its 52-week high, which contributed to SoundView analyst Jim Mendelson's decision to downgrade his rating on the stock last week to hold from buy. His firm hasn't done any banking with SAP.

Such multiples made more sense when business was growing 30% to 35%, but they aren't supportable when the growth is down to 10% to 15%, said Bill Schaff, portfolio manager of the Berger Information Technology fund. "I'm not overly enthusiastic and don't see a pickup in spending that drives sales," he said.

Oracle, trading down 42% since the beginning of the year and at a historically low

price-to-earnings ratio of 18, may be cheap if you have a long time horizon, but few investors do these days, Schaff said. "We all have the patience of a flea," he quips.

Schaff believes Oracle is fairly valued at $8 and said he'd be more interested in buying if it falls to the $6.50 level. "That's not a valuation call; it's more of a sentiment call," Schaff said. "They've lost so much investor confidence."

Based on analysis of 48 software stocks, WR Hambrecht enterprise-software analyst Rich Petersen also argues the sector is fully valued. The average stock price fell 21.5% from March 1, before the dismal earnings season, to April 26, at the season's end, Petersen found. But the average forward-looking P/E ratio fell to only 32.8 from 40.5 -- a 19% decline.

"That's not a huge adjustment considering an entire sector just blew up," Petersen said. "Stocks have come down a lot. But really, are they a lot cheaper? I think the answer is no. Estimates fell a lot."

Add to that the lack of visibility and you hardly have a recipe for upside, he said.

In addition, Petersen found that enterprise value (market capitalization plus debt minus cash)-to-sales ratios declined 23% from March 1 to April 26. As a corollary to that ratio, Petersen found that average estimated sales growth rates for December-year-end companies declined to only 16.5% as of April 26 from 19% on March 1.

Overestimating the Recovery

Petersen believes that sales estimates still reflect a more robust 2003 software recovery than may be called for. In other words, analysts may be making stock valuations seem lower than they truly are by keeping estimates up -- and hence P/E ratios down. "Software stocks could be in for another downward move if the turning point for the sector continues to get pushed back as we progress through 2002," Petersen wrote in a report on his analysis.

December-year-end companies reported a deep slowdown in business in March, which was avoided by February-quarter-end companies such as

Manugistics

(MANU) - Get Report

and

Cognos

(COGN)

, which beat estimates. Petersen suggests that the February-quarter-end companies with high valuations may report a difficult May quarter-end based on weakness in March and April. He suggests selling off such companies that also have high relative valuations. Topping that list is Manugistics, currently trading at 31 times earnings.

Ian Murray, a portfolio manager at Straus Asset Management in New York, comes to a different conclusion after looking at enterprise value-to-sales ratios. He said software companies such as

SeeBeyond

(SBYN)

and

Vignette

(VIGN)

are registering enterprise value-to-revenue ratios ranging from 1 to 1.5 -- the lowest levels seen in a decade. "Their pricing is as though they won't grow, and I don't agree with that," Murray said.

During these tough times, analysts and fund managers say, it makes sense to look at enterprise value-to-sales in addition to the P/E ratio. Part of the reason is that earnings have dried up for some companies, making it impossible to calculate a P/E ratio. For other companies, it may be valuable to look at enterprise value-to-sales when margins fall below historic levels. The P/E ratio may not give a complete picture because companies can't adjust their cost structure as fast as the market can push down revenue.

Brent Thill, an analyst with Credit First Suisse Boston, said that three years ago, before Y2K and the Internet boom, software laggards registered enterprise value-to-sales ratios ranging from 1 to 3, while leaders were above 5. The group is now trading at an average of 2 to 3, he says. Thill's conclusion: There's room for upside if the economy improves.