Without a doubt, the Age of the Internet touched every sphere of the business world. But perhaps no industry has benefited more than software as a service -- commonly given the SaaS nomenclature. We're here today to give you the names of three SaaS stocks that are strong buys today.
If you're new to investing, or even to the SaaS concept in general, think of Google Docs. You don't have to download any of the software to use the applications, and all of your data is stored on the cloud for you. SaaS companies simply have more complex and personalized solutions that they charge for. Once the set-up costs are realized, margins can be huge given such low maintenance and overhead costs.
When Amazon and Facebook throw in the towel, you know you have a winner
Brian Stoffel (Shopify): I'm a big fan of the business momentum Shopify has going right now. The company was founded in 2004 when CEO Tobias Lutke was trying to start a snowboard company in Canada. He couldn't find a single suitable platform to help sell his goods. So instead of sticking with snowboards, he designed a SaaS company that would work for him -- and countless others ever since.
There's a lot to like about the company: It is founder-led, and insiders own 57% of shares outstanding. Further, there are high switching costs, as any small or medium-sized business would rather spend time on their primary product than figuring out a new platform to sell goods online. And with every additional merchant, the company collects even more data to better serve its customers.
But perhaps the biggest sound-bite victory for the company is that Facebook and Amazon have given up on projects to develop their own e-commerce platform and are instead allowing vendors to use the Shopify application as the preferred solution. That's some serious street cred.
While some might argue that an unprofitable business shouldn't be trading for the valuations Shopify fetches, I look at the company's rapid growth in customers and revenue and think that reinvesting in the business right now is absolutely the right move -- and it should pay off in years to come.
Expensive, but worth it
Brian Feroldi (Paycom Software): One of my favorite reasons to invest in SaaS companies is that they benefit from a recurring revenue business model. As long as the company c an it loses to churn, its numbers will continue to head in the right direction.
Paycom Software is a fast-growing SaaS company that has been knocking the cover off the ball for years. The company targets small and medium-size businesses that are looking for a better way to manage their basic HR functions like payroll processing, time and labor management, talent acquisition, training, and more. Unlike other payroll processors that only handle one of two of these processes at a time, Paycom's software combines all of these functions into a single, cloud-based system. That makes it far easier for HR departments and employees alike to get their jobs done.
It is clear as day that the company's simple product offering is resonating with businesses everywhere. Paycom's revenue has been growing rapidly for years. So quickly, in fact, that the company has already become profitable.
The only knock against Paycom is that the markets are already paying up for the company's terrific growth and business model. Shares are currently trading hands for roughly 70 times trailing earnings, which is a quite a premium valuation. While that's pricey, I for one believe that this is such a high-quality company that it has more than justified its premium valuation.
An older company transitioning to SaaS
Keith Noonan (Adobe Systems): Adobe Systems has seen its stock price climb to new heights as a result of a successful transition to a subscription-based model, but it still looks like a worthy investment even in light of pricing highs. The company is most known for its Photoshop software, and it maintains a leadership position in the design space at a time when visual communication is becoming increasingly important thanks to the dominance of mobile advertising and the emergence of new mediums like virtual reality and augmented reality.
Adobe's transition to a SaaS model has already proven to be successful, and it should continue pushing top- and bottom-line gains. The company's fourth-quarter report saw it grow sales 23%, while total fiscal year revenues climbed 22% and annual subscription revenues increased 42% to $4.58 billion -- or roughly 78% of annual sales. The shift to recurring revenue is also boosting in profitability. Diluted earnings per share increased roughly 87% from fiscal 2015 to 2016, and analysts are forecasting for roughly 25% growth in fiscal 2017 and 29% in 2018. While Adobe stock trades near lifetime highs, the company's forward earnings multiple of roughly 28 is actually low compared to where it's been over the last two years.
Adobe's core design, marketing, and project management solutions look poised to retain leading positions, and the company is just starting to see benefits from the growth of virtual and augmented reality technologies. The VR and AR markets are expected to be worth a combined $150 billion by 2020, and Adobe's forefront position in 3D design put the company in good position to play a core role in delivering content for the new formats. With a potentially huge growth driver in sight and the success of its transition to SaaS, Adobe stock looks like it can continue building on its incredible success.
Brian Feroldi owns shares of Paycom Software. Brian Stoffel has no position in any stocks mentioned. Keith Noonan has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Paycom Software and Shopify. The Motley Fool recommends Adobe Systems. The Motley Fool has a disclosure policy.