This Sticky Stock Is a Steal

In most walks of life, sticky is bad, if not downright disgusting. Nothing ruins my day more quickly than stepping in gum or grabbing a door handle that leaves a surprise between my fingers. But in investing, sticky is great -- at least when it comes to revenue.

Simply stated, companies that generate sticky revenue hold up better when the economy is lousy. Finding these businesses can help you find winning stocks in low- and no-growth environments like we have today.

Why is sticky stellar?
Sticky revenue goes by many names: recurring, subscription or annuity revenue, just to name a few. Whatever you call it, sticky revenue is predictable and stable. It represents sales that we feel comfortable counting on in the future.

Companies that have it can invest in capital projects more confidently, and can focus their efforts and money on generating new sales. We benefit as shareholders because stable cash flow encourages growth investment, dividends, and share repurchases.

Consider an automobile manufacturer and a mechanic. The carmaker sells you a car once, books that single sale, and doesn't hear from you again until years down the road, when you're ready for a replacement or need a Volvo (with extra airbags) for your 16-year-old. The automaker's sales are one and done.

Meanwhile, your mechanic gets to know you by name, thanks to oil changes every 2,000 miles, scheduled maintenance every 30,000 miles, and touch-ups from time to time when permit-wielding Junior sideswipes the mailbox. As you can see, frequency plays a role in explaining why recurring revenue is so special.

A second reason sticky revenue matters has to do with consumer behavior. When times are tough, consumers are more likely to suspend new purchases than they are to alter existing purchasing habits. For example, in the event of an economic downturn, most car owners would opt to delay the purchase of a new car, instead of skipping an oil change.

In search of stickiness
The mechanic example above is an example of subscription/servicing sticky revenue, but there are other flavors. A popular example is Procter & Gamble (NYSE: PG) and its razor-and-blade sticky-revenue model.

Even as the rugged look (see Matthew Fox from Lost) and bum look (see Zack Galifianakis from The Hangover) refuse to go the way of the bell bottom, most of us shave every day. In economic booms and busts, we buy razor blades every month, resulting in two brands (Fusion and Mach3) that each generate sales of more than $1 billion. P&G is hoping its Fusion brand will prove sticky, too, with the release of its ProSeries line of razors and skin care.

A lesser known example of sticky revenue comes from providing a mission-critical, behind-the-scenes service. Jack Henry & Associates (Nasdaq: JKHY) provides software and processing services to more than 11,200 small and midtier banks. Without these services, smaller banks would have to take mundane (but vital) tasks like electronic funds transfer and online bill payment in-house and wouldn't be able to compete profitably with larger competitors. 

As a result of its sticky revenue sales, Jack Henry has trounced the S&P 500 over the past 20 years, generating annualized returns of 29% per year versus only 7% for the market. With its recent acquisition of iPay Technologies, Jack looks to be adding mission-critical services (and more sticky revenue) going forward.

Sticky is as sticky does
Sticky revenue doesn't necessarily translate to market-beating results like at Jack Henry. However, during the economic downturn, when generating sales has been tough, companies that benefit from the resiliency of sticky revenue have had an easier go of things:

Steal this sticky stock today
Automatic Data Processing (Nasdaq: ADP) is truly one of the world's great businesses. It provides payroll processing and benefits administration for 550,000 clients worldwide. It gets paid for making sure you get paid.

While payroll processing isn't rocket science, it's a pain for employers because it is data heavy, deals with rules that change frequently, and requires attention every pay period. Because of its massive scale, experience, and technological prowess ADP can handle payroll much more efficiently and cheaply than a human resources department.

Better yet, because payroll is mission critical (employees will leave if they aren't paid!) customers tend not to switch providers very often, which gives ADP significant pricing power. Its customer retention rates are on the order of 90%! Now that is what I call sticky.

So what's not to like? Well, growth has disappeared -- lost jobs translate to fewer paychecks to process. In addition, ADP earns money on cash waiting to be sent out in paycheck form. At any given time, these funds range from $15 billion to $20 billion. With interest rates so low, the company's interest income has been puny.

But ADP has continued to invest in its business through the recession and has actually grown its non-payroll businesses. And any increase in interest rates will drop right to ADP's bottom line. I think shares could be worth $60 (they're at $49 today), and with a pristine balance sheet, 3% dividend yield, and steady free cash flow, shares are attractive right now.

Make money in every market
Finding companies that benefit from sticky revenue is tough, but the payoff is worth the hunt. Uncovering market leaders with the stickiest revenue streams is one of the ways that Motley Fool Pro copes with a sluggish economy. If you agree that sticky is beautiful, and you want to learn more, drop your email address in the box below.