The share-price growth of some companies is gradual and compounded, but some is rapid after arriving at a tipping point. Sage (LSE:SGE) is a provider of integrated payroll and accounting systems, which appears to have arrived at the hinge between being a dependable UK share and being a wildly profitable part of a portfolio.
In the current climate of double-digit inflation, soaring interest rates and a slowing global economy, many firms have posted modest forecasts for the year ahead. Sage, however, has bucked the trend with its optimism that these trepidatious conditions will result in greater operating profit and margins.
In my mind, this is not just tough talk aiming to pique the interest of bullish investors. Rather, it is a dispassionate assessment of strong financial foundations and a successful transition to a new, more profitable business model.
Previously, Sage operated on a pay-as-you-go basis. Clients paid per task or agreed contracts in advance. This meant that clients could easily shop around, and that business was sporadic. As a result, profitability wasn’t at its optimum and cashflow was inconsistent, a factor that made future planning difficult.
Now, however, Sage has shifted to a subscription model. This has ended its barriers to expansion and profit in one fell swoop. Cashflow is constant and clients have committed to the company. The bearish climate also aids Sage’s new model as the high switching costs for the many small- to medium-sized firms that make up its clientele result in high retention rates. It can now rely on a more solid base on which to expand operations from. Subscriptions also give it greater pricing power in what it charges for its services, in a welcome hedge against inflation. It also ensured greater total takings, with revenue increasing by 12% this year.
This impressive transition is not set within a vacuum. It has crowned the company’s sound financial position. Its operating margins rose to 19.9% in the 2022 financial year, a feat sped up by strategic acquisitions fuelled by its lofty status quo. In a difficult strait, many bargains are to be had as companies encounter difficulties.
With money in the bank and net interest costs covered 12 times by profit, Sage could cheaply acquire small companies or comfortably leverage further debt to devour meaty entities. As such, its profitability could come on in leaps and bounds on account of its acquisitions.
From tending my portfolio, I have learnt that investing is not a science where a data-orientated system can faultlessly choose winners. It is reliant on the perception of companies by human investors, the famous “animal spirits” of Keynes. Thus, in bull markets awash with easy money, the fundamentals of a successful business are oft overlooked in favour of trendy, hyped industries like tech.
Now, where I believe even a store of wealth against inflation is at a premium, such desirable qualities are less likely to be overlooked. Indeed, it is possible that a scarcity premium will lift their value. As such, my feeling is that Sage is a stock for the next year on the basis of its balance sheet, but its new model gives it potential to remain in my portfolio for the next decade.
