We get very contemplative at the end of the year. We review where we are in life. Often, it's a good reminder to look over our portfolio and consider making changes. Below, we'll review three mid-cap stocks that deserve a spot on your wish list heading into 2020.
You'll notice that all three have one very big thing in common: They use the software-as-a-service (SaaS) business model. That's not a coincidence. After spending money to build top-of-the-line solutions (the hard part), it costs very little to give customers access to the software. And the model often has a wide moat in the form of high switching costs.
But these three stand at the top of their class. As mid-cap stocks (valued between $3 billion and $15 billion), they all have lots of room to grow, too.
Image source: Getty Images
Axon's sneaky pivot to SaaS
Axon Enterprise (AXON 2.36%) wasn't always an SaaS company. It was previously known as TASER International. But in early 2017, it changed its name to highlight its new focus: police body cameras. The cameras aren't the really special things, though; it's the Evidence.com platform that stores and analyzes all of that footage.
When a police department starts to store and analyze all of its footage in one place, it is highly unlikely to leave. That means each additional "seat" (read: officer) added is recurring revenue for the long haul. And those seats have been adding up.
Data source: SEC filings.
There are also several new products on the horizon that utilize Evidence.com data. Valued at just $4.3 billion, Axon is a high conviction mid-cap to buy and hold.
Managing identity in the digital age
The fact that everything is connected in today's world leads to greater efficiency. Those improvements, however, come at a price. If everything is stored and accessed via the Internet, tons of data can also be stolen or compromised via the Internet. In the days of paper files, that wasn't possible.
The second stock on our list, Okta (OKTA 1.41%), was designed to combat this problem. The business' subscription software helps companies make sure that people are who they say they are, before giving them access to sensitive data and tools. There are currently 12 products Okta offers to help manage employee and customer access.
As the company has started going after bigger and bigger clients, the most helpful metric to monitor is its backlog of billings -- or remaining performance obligations (RPO). This measures the amount of guaranteed revenue under contract that has yet to be realized. In other words, if you pay for three years of service at once, only a tiny slice ends up in revenue each month. RPO gives a fuller picture.
Data source: SEC filings.
Note that these figures are presented for each quarter above, not by year. Okta only began disclosing the number in early 2018. Since then, RPO has grown by 62% per year.
Once a company starts using one of Okta's tools, it will often add more over time. The more tools being used, the harder it is for a company to switch away from Okta. That forms a solid moat around the company. Okta is a bit larger -- valued at $14 billion today -- but managing identity will be very important in the digital age, which makes it a core mid-cap holding.
Taking care of customers
Modern technology has created a power shift in the marketplace. Just-in-time manufacturing combined with social media reviews of goods and services have put customers in the driver's seat. So if a business doesn't take care of its customers, it's toast.
That's what Zendesk (ZEN) aims to do. The company's core subscription software tool is Zendesk Support. It helps companies keep track of every interaction with a customer, making sure that no matter who picks up the phone (or answers an email), they can see the entire history of interactions and resolve all issues.
The product was so popular that Zendesk also offered up a Chat tool and a host of "Other" services that cost a monthly subscription. It's the growth of the "Other" tools that really has me excited.
Data source: SEC filings.
These tools include an analytic tool (Zendesk Explore), sales software (Zendesk Sell), a customer relationship management platform (Zendesk Sunshine), and more. As with the previous two companies, when customers add more and more tools over time, switching costs become high. This essentially locks in recurring revenue for long time horizons.
The importance of taking care of customers will only grow over time. With an $8.4 billion valuation, that makes Zendesk a mid-cap stock worth owning today.
Preparing for the year ahead
It should be noted that all three of these companies are valued at multiples that most would consider "expensive." But you don't need to buy a position all at once. If these stocks interest you, consider buying a small starter position and adding to it over time.
And lest you think these are empty words, these three stocks make up over 13% of my real-life portfolio. They all, I believe, deserve consideration heading into the new year.
