When inflation hits, it tends to have (often negative) effects on everybody, from consumers to corporations. The higher cost of products and production tends to lower profits and make it harder to keep growing. A mark of a great business is its ability to pass along those inflationary costs to its customers without losing sales. Also referred to as "pricing power," it's a characteristic of great companies and famed investor Warren Buffett says it's the "single-most important [variable] in evaluating a business."
Software companies tend to develop products with pricing power. While some software programs are nice to have, others are vital for day-to-day operations. For engineers and architects, computer-aided design (CAD) and simulation software are irreplaceable and used daily. Two leading companies in this space are Autodesk (ADSK 0.71%) and Ansys (ANSS 2.05%). While neither is likely to produce explosive growth, these companies provide consistent returns both in good years and bad and can turn their pricing power into strong stock returns.
Image source: Getty Images.
1. Autodesk
Autodesk's software is used by architects and engineers across the world to help create buildings and products seen every day. Its AutoCAD software has been around since 1982 and has become a staple for students studying these fields. Autodesk bills its users on a subscription basis and gives the best price points to those who purchase multi-year licenses.
When a business deploys Autodesk's product suite, it soon learns there are high costs to switching to a competitor. Thousands or millions of files would have to be migrated from one format to another, and there could be issues with the crossover, resulting in lost work. Additionally, the space is mature, and consolidation has already occurred, leaving few competitors to switch to. All this means Autodesk can pass on regular price increases, as businesses are virtually locked in.
2021 was a successful year, with revenue rising to $4.82 billion, a 16% increase. It ended the year on a high note, with fourth-quarter revenue increasing at a slightly higher 17% clip. The business also has high margins, with 59% of revenue being converted into free cash flow. Some lease changes occurred during the quarter, so its GAAP (generally accepted accounting principles) earnings per share (EPS) metric took a temporary hit, but its non-GAAP EPS was up $1.50 year over year, or 27%.
Autodesk is deployed across the world, which diversifies its income streams and mitigates effects from recessions or geopolitical risks. Here's a look at how the revenue is split geographically.
| Region | Share of Fiscal 2022 Revenue |
|---|---|
| The Americas | 40% |
| Europe, Middle East, Africa (EMEA) | 39% |
| Asia-Pacific (APAC) | 21% |
Data source: Autodesk.
For 2022, Autodesk management guided for 14% to 17% revenue growth, practically the same as 2021's numbers. On the non-GAAP basis, management expects $6.46 to $6.83 EPS, up from $5.07 in 2021 and $4.05 in 2020. With profits growing faster than revenue, Autodesk is a mature business that could begin returning profits to shareholders through buybacks or dividends in the future.
With the stock price down more than 40% from its all-time high and trading at about 30 times price-to-free cash flow, investors can confidently buy the stock at a reasonable valuation.
2. Ansys
More specialized than Autodesk, Ansys provides simulation software for engineers to model how products will perform without physically prototyping them. By running simulations, engineers can reduce development costs and maximize function. Ansys' products are often recognized as best in class and span many fields, including semiconductors, structures, fluids, and photonics.
Ansys has multiple competitors, but none have a product suite as wide as Ansys, giving it a competitive advantage, as the programs can feed information into each other. With software that can simulate how cutting-edge technologies like autonomous driving, 5G, and vehicle electrification work, Ansys has a growing use case for engineers everywhere.
Image source: Getty Images.
While revenue is a telling metric, management believes its annual contract value (ACV) better conveys how the business is performing. Full-year 2021 revenue was only up 5% year over year, but ACV was up 16%. Non-GAAP EPS was $7.37, up 10% from 2020's $6.70 value.
2022 guidance was not as good as Autodesk's, with management expecting anywhere from 6.6% to 10.3% revenue growth and 6.4% to 9.6% ACV growth. Currency fluctuations will play a big role, as constant currency ACV growth would be 8.3% to 11.5%. Ansys may have pricing power, but with inflation affecting the U.S. dollar, any business with significant international exposure will be affected.
Ansys' stock price is down 25% from its all-time high and is valued more richly than Autodesk, at 52 times free cash flow. However, it has seen significant multiples expansion over the past three years.
ANSS Price to Free Cash Flow data by YCharts
With the run-up in valuation, investors may not be getting the cheapest price possible for Ansys stock. Still, it is at a recent low and hasn't reached this price since the pandemic's beginning. Valuation isn't everything when picking stocks, but it is something to consider.
Are these stocks a buy?
Both businesses provide vital software, powering innovation and new construction everywhere. An investment in either business doesn't expose shareholders to a single company's boom or bust; it spreads out risk by betting on all of them. Both companies make great picks for investors looking to add mature businesses to balance out high fliers, although Autodesk looks like a better buy right now with higher growth and a lower valuation. Still, investors should feel confident in holding either stock for three to five years.
