Revenue is the lifeblood of a company. Without money coming in at the top line, there will be no profit at the bottom line. But not all revenue is equal -- and recurring revenue is definitely a cut above the rest.
Less and more reliable
A company that sells pianos won't have the most reliable revenue. A family might buy a piano just once or twice in a lifetime, if ever. And in tough economic times like we've experienced over the past bunch of years, many would-be buyers of pianos will postpone such purchases as luxuries they can ill-afford.
Revenue tied to less optional purchases is far more reliable. If you're going to propose to your love, you'll likely want to buy a diamond ring, and you probably won't want to put off the purchase for too long. That assures Zale and other jewelers at least a baseline level of revenue. Then again, chances are you won't be proposing with diamonds very often in your life.
Recurring revenue, which a company can pretty much rely on receiving regularly, is far more attractive. It's one of the key traits that Vitality Katsenelson, in The Little Book of Sideways Markets, recommends we seek in outstanding stocks. "A high level of recurring revenues creates higher predictability and sustainability, and this reduces risk for investors," he notes. "It also removes a lot of strain from growth, since a company with high recurring revenues has to put forth a lot less effort to grow revenues."
A profitable transition
That lesson's not lost on many companies; some have shifted their business models to include more recurring revenue. Kimball International, once known as a piano maker, gradually began adding more businesses under its umbrella. Today, you'll have trouble finding the word "piano" on its website. As electronic keyboards have grabbed business from old-fashioned pianos, Kimball's decision to evolve looks better and better, especially since some of the company's new businesses offer recurring revenue. Kimball now generates more reliable income from office furniture and automotive supplies, and gets recurring revenue from offerings such as disposable urinalysis test strips.
Lots of flavors
There are many different kinds of recurring revenue. The classic example is the razor blade, which people buy over and over. Prescriptions are another good example. If you have high cholesterol, you'll likely take a medication such as Abbott Labs' (NYSE: ABT ) TriCor repeatedly for a long time, whatever the state of the economy or your wallet.
Once we buy insurance to protect our homes, cars, or lives, we tend to keep paying the same company for the coverage for many years. That adds a degree of stability to insurers' earnings, benefitting outfits such as GEICO and other insurers. Companies that offer subscriptions also benefit from recurring revenue -- these would include Netflix (Nasdaq: NFLX ) and TiVo (Nasdaq: TIVO ) , Internet service providers, phone service providers, and cable TV providers. Most satisfied subscribers will keep paying month after month, year after year.
Many companies successfully pair one-time or infrequent purchases with recurring revenue. Razors and blades may be the most popular example, but bigger-ticket items can also fit the bill. You may buy a Garmin (Nasdaq: GRMN ) GPS device just once in a blue moon, but every year or two, you'll likely spend money to update its maps -- if you don't just buy a whole new machine. And while a hospital may buy just one million-dollar robotic surgery machine from Intuitive Surgical (Nasdaq: ISRG ) , it will likely buy lots of supplies and accessories for that machine for years to come. A company may sell you a $100 printer, and then reap several hundred dollars from you for the ink cartridges it requires.
Licensing is another great model. Many tech-heavy companies such as InterDigital (Nasdaq: IDCC ) , Qualcomm (Nasdaq: QCOM ) , Oracle, and SanDisk (Nasdaq: SNDK ) make big money licensing their proprietary intellectual property to others.
Recurring revenue appears in many different forms. The bigger a role that recurring revenue plays in a company's business model, the greater the odds that it may be a worthwhile investment.
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