A person visits a website. They look for something. They can't find it immediately. They leave the website, never to return again. 

How many times has this happened? How many customers have companies lost because of e-commerce-related problems they were never aware of in the first place? The honest answer: They may never know.

But no more. The hot stock that I'm buying this month -- New Relic (NYSE:NEWR) -- is turning these sales woes into reasons to celebrate for more than 17,000 paying clients.

Cartoon businesswoman expressing different emotions

New Relic is having this effect on its customers. Image source: Getty Images

Look back 20 years, and businesses' once-small IT departments had comparatively modest duties. But with the rise of the internet, the explosion in mobile computing, and the onset of the apps era, those departments are being asked to do far more. Their headcounts may have grown, but they haven't generally kept pace with the growth in computing needs -- which means many such departments are swamped.

New Relic has helped pioneer a niche -- Application Performance Monitoring (APM) -- and delivered a software-as-a-service (SaaS) solution that can significantly ease their burdens.

The company is still run by founder Lewis Cirne. He owns  17.4% of shares outstanding, and gets rave reviews from employees -- and a 95% approval rating on Glassdoor, which lets employees weigh in anonymously. The company overall garners a strong 4.2 stars (out of 5) on the website. That helps explain why I'm glad to invest now alongside this owner-operator and his motivated workforce, even though the stock has advanced 130% in the last year.

Undeniable momentum

The company gets its foot in the door at IT departments by offering the New Relic Platform. This basically takes tons of data and breaks it down into an easy-to-understand dashboard that can be monitored in real time. Often, companies test-drive the solution by using the flagship product: New Relic APM.

As a client gets more familiar -- and comfortable -- with APM, it can expand into new offerings: New Relic Mobile (monitoring mobile apps), New Relic Browser (showing what the experience is like for a visitor to your site), New Relic Synthetics (simulating a new software before deploying), New Relic Infrastructure (increased visibility across entire infrastructure), and New Relic Insights (big-data analytics).

Over the past five years, the company's revenue growth has been impressive.

Chart of New Relic revenue over past five years

Chart by author. Data source: SEC filings

Over that same time frame, the number of paid accounts has increased 87% to 17,000. Surprisingly, though, this isn't even my favorite part of the New Relic's young story.

Becoming embedded in customers' corporate DNA

Finding a great solution for a growing market opportunity is great. But if the company you are investing in doesn't have an identifiable moat, the competition will eventually eat away at the first-mover advantage. That's why moats matter -- they help protect your turf.

New Relic has a moat: It is becoming more and more embedded within its customers' operational DNA. Once an IT department has been trained on New Relic's platform, and has deployed the solution across multiple branches of a company's operation, switching costs become high. 

No metric better highlights this than the company's dollar-based net expansion rate (DBNE). This basically compares the total revenue from a set of customers in year one to the total revenue from the exact same set of customers in year two. If the rate falls below 100%, it either means customers are leaving or they are paring down the number of New Relic solutions they are using. If it's going up, the company is expanding its presence in those companies' IT departments.

Metric
2013 2014 2015 2016 2017
DBNE 116% 130% 140% 133% 141%

Data source: SEC filings

The annualized DBNE at the end of the fiscal year for New Relic is incredibly strong, and shows customers are signing up for more and more add-ons after using the flagship New Relic APM.

Improving fundamentals

I don't tend to worry too much about valuation and profitability when it comes to SaaS companies with the characteristics New Relic has. That said, I understand why they are important to other investors.

On those fronts, New Relic might seem too expensive. It has yet to turn a profit, and trades for 425 times trailing free cash flow -- but the trends are decidedly in New Relic's favor:

  • The company has $248 million in cash and investments on hand against zero long-term debt.
  • It became free-cash-flow-positive for the first time last year, generating $14 million.
  • After backing out stock-based compensation, operating margins have improved markedly -- the company's non-GAAP loss was just 1.75% of revenue last year. Three years ago, it lost an equivalent of 24.47% of revenue.

For all of these reasons, when Motley Fool trading rules allow, I will be adding shares of New Relic to my own portfolio. It will occupy less than 2% of my overall portfolio -- as it is a smaller stock, more prone to volatility, and one that I'm adding for the first time -- but I'll be open to buying more as time goes on. I think you should consider doing the same.

Brian Stoffel has no position in any of the stocks mentioned. The Motley Fool recommends New Relic. The Motley Fool has a disclosure policy.