Ask the Rational Investor: Investing in Critical Software
Long-term investors attempt to predict what a business may look like in 3, 5, and even 10 years into the future; believing that long-term value creation comes from owning a great business for many years.
Depending on the business, forecasting the future can be quite challenging. One business niche that has historically been easier to predict is that of products critical to operating a company every day. These products or software are deeply integrated into all aspects of a business and as a result, customers are less sensitive to price increases and switching providers is complex and time-consuming.
A classic example is the Microsoft Office suite. Most businesses use Windows, Outlook, Word, and other programs every day. As you likely know, Microsoft now sells its software in the cloud on a subscription basis, compared to CD-ROMs that could be kept and only upgraded every few years.
Similar trends exist in other mission-critical software packages such as Adobe, Salesforce, and Autodesk, to name a few. These companies are predictable and highly profitable, but current valuations generally reflect investor enthusiasm.
Salesforce’s stock price hasn’t performed well recently, falling from the low $300’s to about $255 per share today, as investors were disappointed with the backlog of new subscribers.
One inefficiency in the stock market is when high-growth companies begin to decelerate. Investors previously willing to pay high valuations for growth, sell shares as they become disappointed with slowing growth. When this happens, companies occasionally no longer have a clear “owner,” such as growth or value stock-pickers. During this inflection point in these companies’ lifecycle, sales growth has started to slow, but profit margins are expanding, and investors are rewarded with more predictable financial results.
Salesforce has become the leading customer relationship management (CRM) software package for most businesses, and growth certainly hasn’t disappeared as investors expect sales to nearly double from $21BN in the fiscal year 2021 to $43BN by 2025.
Patient long-term investors are likely to be rewarded with Salesforce’s stock!
Sources: Company reports
Beese Fulmer Private Wealth Management was founded in 1980 and is one of Stark County’s oldest and largest investment management firms. The company serves high-net-worth individuals, families, and non-profits, and has been ranked as one of the largest money managers in Northeast Ohio.
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