I recently highlighted investment platform Hargreaves Lansdown as a FTSE 100 stock that I would buy and hold forever. Today I’m going to look at another business that I think has similar qualities to this fund management platform.
Sticky income
The best buy-and-forget stocks are those companies that have a sticky business model and durable competitive advantage, or to put it another way, companies that have established themselves as the best operator in their sector and are difficult for customers to leave.
Accounting software provider Sage (LSE: SGE) ticks both of these boxes. Not only is this company one of the leading accounting software providers in the UK, but it is also tough to switch away from the business as doing so means transferring all historical accounting data, which as any business manager will know, is extremely time-consuming and more often than not, is not worth the effort.
However, it hasn’t been plain sailing for Sage over the past 10 years. Traditionally, the business relied on selling software to customers with a CD, but over the past decade, the world has transitioned away from CDs and DVDs towards cloud computing and streaming.
Sage was caught out by the shift and was relatively late in producing its cloud offering. Luckily, the company has now caught up.
Since 2014, revenues have jumped by 37%, and net profit has nearly doubled. Analysts are expecting more of the same over the next two years. By 2020 they expect the business’s net income will hit £364m, up from £300m in 2017, on revenues of £2.1bn. And because it is so complicated and time-consuming to move away from Sage’s software offering, I reckon the company’s earnings will continue to grow at a steady rate for the foreseeable future, which is exactly what I want to see in a buy-and-hold-forever stock.
As well as its impressive rate of growth, shares in the company also support s dividend yield of 2.4%.
Overvalued
Sage is, in my opinion, one of the most attractive software stocks you can buy right now. Unfortunately, I can’t say the same for Tracsis (LSE: TRCS).
Tracsis provides software services for the rail, traffic data and broader transport industries and it has achieved some impressive growth over the past five years.
Sales and earnings have roughly doubled since 2014 with net profit hitting £7.3m last year, from £3.3m in 2014. City analysts are expecting the company to report earnings per share growth of 55% this year to 26.8p, which puts the stock on a forward P/E of 23.3. I think this is relatively expensive compared to the firm’s growth (it trades at a PEG ratio of 2.8) and other figures tell me this business isn’t as attractive as Sage.
For example, the company isn’t as profitable. It reported an operating profit margin of 21.5% last year, compared to Sage’s 23%. At the same time, the group’s return on equity was just 19% last year, compared to Sage’s 24%.
These profitability metrics tell me Tracsis should trade at a discount to its larger peer, but the stock is trading at a slight premium, and that’s why I think Sage is the better buy.
