There is no point crying over spilt milk and that includes as an investor. However, sometimes it can be tempting. Take software company Sage (LSE: SGE) (and it is easy to wish I had!). I was eyeing Sage shares going into last year.
I did not buy them.
Since then, however, they have gone up 52%. That puts them 85% higher than they were five years ago.
So, why did I not buy and what lessons can I learn to try and improve my future investing returns?
First I will go through three reasons why, then as now, I felt Sage could be very attractive to a long-term investor.
Reason one: large, resilient demand
I look to invest in businesses that are responding to the needs of a sizeable market I expect to endure and ideally to prove resilient across the economic cycle.
Sage fits that description perfectly. Millions of small and medium businesses in its markets around the globe need to perform accounting functions from book-keeping to issuing invoices.
By providing them with a solution to this need, Sage can tap into that strong demand from professionals with money to spend on the right solutions.
Reason two: installed customer base and sticky product
Not only that, but Sage has what is known as a sticky product.
In other words, once it is in use it is hard to get rid of.
Sure, clients could switch to one of the firm’s rivals if they wanted to. But think of all the training, lost hours, and frustration that might cost if they had spent years working on Sage and growing comfortable with it.
That gives the company pricing power, which can help maintain attractive profit margins. Sage’s operating profit margin moved up last year from 19.5% to 20.9%.
The company has a large installed customer base. I think its focus on small and medium-sized firms is a strategic masterstroke. They are too big to want to do their accounts on their own, but not big enough to grab the full attention of some of the software giants.
Reason three: clear pathway to future profits
Sage has been consistently profitable in recent years. But it has not been resting on its laurels.
It has recognised risks to its business, from competitors winning over its clients to shifts in the digital space.
Its strategic response has been a clear focus on shifting clients to cloud-based solutions. That can help reduce costs for Sage in the long run, boosting profit margins further.
So… why didn’t I buy?
Given that I thought Sage was a great business a year ago – as I still do – why did I not buy, ahead of the 50%+ share price increase we have seen since then?
In a word: valuation.
No matter how strong a business is, overpaying for it can mean it ends up performing weakly as an investment.
If I thought that Sage shares looked pricy a year ago, what about now?
After the huge run-up in price, the share now sells on a price-to-earnings ratio of 57. No matter how good a company is, I think such a valuation is overstretched.
So, although I missed out on the price increase, I have no regrets about not buying Sage shares last year – and have no plans to do so now.
