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4 Top SaaS Stocks to Buy Right Now

By Evan Niu, CFA - Feb 23, 2020 at 11:14AM

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These subscription businesses are poised to outperform the broader market.

Over the past decade, software-as-a-service (SaaS) has emerged as one of the most resilient revenue models for tech companies to utilize. The subscription model provides considerable visibility into the recurring revenue pipeline while enabling strong operating leverage through scale and simplifying delivery of software for customers. Oftentimes, the best SaaS companies cater to the enterprise, ideally providing mission-critical applications that customers come to rely on.

Some SaaS players have had to adapt and pivot to subscriptions, while others started as SaaS from the beginning. Here are two from each category: Microsoft (MSFT 0.53%), Adobe (ADBE 1.20%), Okta (OKTA 2.84%), and Twilio (TWLO 0.64%).

Satya Nadella in front of a slide showing Microsoft's cloud offerings

Microsoft CEO Satya Nadella. Image source: Microsoft.

Microsoft: Subscribing for productivity 

A mature tech giant, Microsoft's transition to subscriptions was far from certain. Customers used to buy one-time licenses for flagship software suites like Windows and Office, with Microsoft releasing major updates every few years to sell more of those licenses. Under CEO Satya Nadella, the company has executed incredibly well in transitioning its most important cash cows to subscriptions.

Office 365 remains the gold standard in basic productivity apps, while Microsoft 365 bundles in Windows alongside Office and additional security features. Over a quarter of Office 365 licenses are now sold through Microsoft 365, exec Jared Spataro told investors at a Goldman Sachs tech conference earlier this month.

Outside of the enterprise, Microsoft has steadily grown its Office 365 consumer subscribers to 37.2 million. The company is even moving more aggressively into subscriptions with its Xbox gaming business. In addition to Xbox Live Gold, Microsoft added Xbox Game Pass a few years ago. Game Pass subscribers doubled last quarter.

Add in a sustainable dividend, and Microsoft easily becomes a stable SaaS stock with relatively low risks.

Shantanu Narayen in front of a slide that says "Creativity for all"

Adobe CEO Shantanu Narayen. Image source: Adobe.

Adobe: Subscribing for creativity

Much like Microsoft, Adobe historically sold its creative software as one-time purchases, but embarked upon the SaaS transition several years ago. Adobe launched its Creative Cloud way back in 2011, giving subscribers access to its comprehensive suite of flagship tools like Photoshop, Premiere Pro, and Dreamweaver, among many others.

Adobe has similarly done a remarkable job in migrating its business to the subscription model. For example, subscription revenue accounted for just 15% of revenue in fiscal 2012, the first full year after releasing the Creative Cloud platform. Fast-forward to fiscal 2019: Subscriptions represented nearly 90% of the top line, while Adobe grew total revenue by 2.5-fold over that same time frame to a record $11.2 billion.

It's no wonder why Adobe shares have gained nearly 400% over the past five years and are likely to continue outperforming the broader market going forward.

Breakroom in Okta headquarters

Image source: Okta.

Okta: Subscribing for identity

Among the newer generation of enterprise SaaS companies is Okta, which is dominating the booming market for identity access management. Okta has earned strong endorsements from IT consultants like Gartner, which named Okta a leader in its most recent Magic Quadrant analysis in 2019, ahead of tech giants like Microsoft and IBM.

Throughout 2019, Okta delivered a series of beat-and-raise quarterly reports as it continued to grow its customer base while simultaneously expanding relationships with existing customers. The company's dollar-based net retention rate has held steady in the ballpark of 120% for at least 10 quarters. This metric measures how well a company is able to upsell customers on additional offerings, and investors like to see it above 100%.

The next phase of growth could come from abroad, as Okta is prioritizing international expansion in 2020. With international markets currently representing just 15% of revenue, Okta has considerable growth opportunities outside of the U.S.

Twilio logo

Image source: Twilio.

Twilio: Subscribing for communications

As the top cloud communications platform, Twilio provides a broad set of application program interfaces (APIs) for developers to build communications services ranging from marketing to customer service to internal operations, among others.

Twilio is enjoying blistering growth rates: Sales soared 62% last quarter. The company closed its $3 billion acquisition of SendGrid only year ago, and the email marketing service is highly complementary and will yield operational synergies. Twilio now has over 179,000 active customer accounts, while dollar-based net expansion rate came in at a healthy 124% in the fourth quarter.

The company remains unprofitable since it's still relatively young and is investing heavily in future growth, but the stock had already delivered 10-bagger returns at the peak compared to its IPO price of $15 back in 2016. Twilio is in a strong position to maintain that momentum.

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Evan Niu, CFA owns shares of Okta. The Motley Fool owns shares of and recommends Microsoft, Okta, and Twilio. The Motley Fool recommends Adobe Systems and recommends the following options: long January 2021 $85 calls on Microsoft and short January 2021 $115 calls on Microsoft. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$293.47 (0.53%) $1.56
Adobe Inc. Stock Quote
Adobe Inc.
ADBE
$451.02 (1.20%) $5.35
Twilio Inc. Stock Quote
Twilio Inc.
TWLO
$87.46 (0.64%) $0.56
Okta Stock Quote
Okta
OKTA
$107.11 (2.84%) $2.96

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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