The following is an extract from last week's regular feature in the Personal Finance section of the Independent On Sunday. Be sure to pick up your copy this Sunday.
The Sage of Great Britain
The chances are that if you run a small business, you've heard of Sage (LSE: SGE). Or at least your accountant has. The company is the leading supplier of accounting software and related products for personal computers, and small business is its speciality. All sounds rather innocuous. However, if I told you that since floatation in late 1989, the Sage share price has jumped from 130p to as high as 2250p, perhaps that would make you sit up and listen. That's a compounded annual growth rate of 35%. To put that appreciation in perspective, a £10,000 investment in Sage would now be worth almost £200,000.
This week, Sage reported another impressive set of results, for the six month period ended March 1999. Turnover rose 49% to £132.5m, and earnings per share (EPS) jumped 40% to 20.58p. The dividend was raised "only" 10% to 1.18p net -- well below the growth in earnings -- but that is most likely a good sign. It means that the company wants to conserve valuable cash, as it sees plenty of opportunities for future growth. It is only mature companies that should be keen to pay out a large proportion of their earnings in dividends.
With interim results, Sage also announced that it is embracing the Internet as an integral part of its business model. The excellent results, coupled with mention of the "I" word, saw the shares jump 10% last Tuesday.
Sage has been a classic less obvious great investment. It may well prove to an obvious great investment in the future. In the mould of Microsoft, although of course there is only one Microsoft, Sage have been able to develop an essential piece of software, then roll it out across many customers. The software development costs are relatively expensive, but are effectively a one-off charge. After that, the production costs for software are minimal, and that shows in gross margins of a whopping 90%.
You can usually spot a great business by looking at its margins. A high gross margin indicates that the costs of actually making the goods are proportionally very small. As we see with Sage, software companies are great examples of companies with high gross margins. On the other hand, heavy manufacturing companies require lots of resources in order to produce their goods. This is one of the reasons why we've seen a shift change in the market capitalisation of the service sector versus the manufacturing sector.
Sage have built a strong brand name within the small business sector. Ask your accountant if they've ever heard of Sage. That brand name means that when a new small business starts up, the chances are they'll choose Sage as their off the shelf accounting package. On top of that, they've got the classic business model. Stock levels are almost ridiculously low, because the software costs so little to manufacture. Fixed assets are also relatively low, as Sage don't need much in the way of machinery in order to produce their products. Sage receives up front cash for longer term maintenance contracts, giving them a useful cash float. It's not quite the ideal 'buy on credit and sell for cash' scenario, but is not a million miles away.
If that wasn't enough, Sage has the classic repeat purchase product. No-one likes to change accounting systems, so once a company has installed a Sage product, they'll likely stick with it. But companies need to update their packages. Sage must be crying out for a change in the VAT rate, because that would give them a great opportunity to sell upgrades to their 2 million customers. Every time Microsoft brings out an upgraded Windows operating system, Sage has an opportunity to sell an upgraded accounting package to its customers.
The foray into the Internet is another example of Sage looking to leverage its brand name via a strong and loyal customer base. The Internet, above all else, embraces the classic low cost operating model. Simply build one site, and the incremental costs of having 1 or 100,000 people visit it are proportionally minimal. Sage is hoping that existing customers will be keen to take advantage of the Sage web page. Six months down the track, when the customers are hopefully hooked on the idea, Sage plans to charge them for that privilege.
Stock market investors would do well to hunt for companies that have a Sage type business model. Repeat purchase business, strong brand name, high profit margins, and strong cash generator. Warren Buffett is often called the Sage of Omaha. I bet he, like the rest of us, wishes he had discovered the real Sage back in 1989 and let the power of compounding interest do the rest.
My Dimmest Investment
I have watched the stock market rise and rise over the past few years. I know I want to invest in it, but I still haven't. Many people have been saying for a long time that the stock market is overvalued, so I've been sitting on the sidelines waiting for a market crash. Whilst I've sat and waited, the market has risen over 100%. -- A.M., Middlesex
The Fool responds: It is impossible to successfully time the stock market. Market corrections intermittently happen, but over the long term the direction has been inexorably upwards. If you are afraid of taking the plunge now and throwing all your eggs into one basket, why not consider dripping money into the market on a monthly basis? Cheap index tracking funds allow you to do this. That way, if the market keeps rising, you'll be able to benefit. If it crashes, that will be the buying opportunity you've been waiting for.
Ask The Fool
A Unit Trust Group in which I have holdings is converting to an "Open Ended Investment Company," which they say will be better for investors. Can you clarify and comment? -- G.P., Bromyard
The Fool responds: Open Ended Investment Companies (OEICs) are the new form of unit trusts acceptable throughout the European Union. UTs were only really marketable in the UK because of the UK legislative background. They will generally have single pricing rather than the bid/offer spread that most UTs use. Some people believe that this might be more attractive to the investor. The charges will still remain, of course, although in a different form. The advantage for the managers of converting to an OEIC from a UT is that they can market the fund in Europe rather than just the UK. Other advantages of OEIC legislation include the point that umbrella funds can be formed to enable investors to switch more easily between funds run by the managers. At present, with UT legislation, this is not possible, and a separate trust fund must be set up for each trust run by the managers, with all the attendant costs that are entailed.
Foolish Trivia
Name the company, best known for its pest control, that had 20% of its share value wiped out last Tuesday following a profit warning. (Last week's answer: Allied Domecq)
