Software businesses can be fantastic growth investments. If they become more popular, they can sell more licences with very little additional investment. These incremental sales can be almost pure profit.
Today I’m looking at two specialist software groups that have become very successful. I believe that both have the potential to deliver big gains for investors.
Keeping track of the cash
Running a big business is as much about financial management as operational execution. Successful companies usually have good financial controls.
Microgen (LSE: MCGN) is one of the world’s leading providers of the software used by chief financial officers for financial analytics, compliance and reporting. The group also provides systems used by wealth management firms to administer funds and trusts.
Although this isn’t a start-up, it’s still growing fast. Organic sales rose by 37% last year, while total revenue was boosted by acquisitions and rose by 46% to £62.6m.
Looking at the bottom line, I can see that operating profit rose by 35% to £11.1m, giving a healthy operating margin of 17.6%. Earnings rose by 55% to 16.4p per share and shareholders will enjoy a total dividend of 6.25p per share, an increase of 25% from 2016.
Can this stock keep rising?
Today’s strong results were broadly in-line with expectations and the shares only rose by 2% in early trade. The good news is that recent strong momentum is expected to continue.
Analysts have pencilled in earnings per share growth of 20% for 2018 and a 17% hike to the dividend. This leaves the stock trading on a 2018 forecast P/E of 27, with a prospective yield of 1.4%. That’s not cheap, but in my view this is a quality business in a growing market. I believe these shares could still be a profitable long-term buy.
Microgen’s customers are generally quite sticky, as a lot of work can be required to move to a rival. That’s also true of my next stock, online marketing specialist dotDigital Group (LSE: DOTD).
This firm produces dotmailer, an enterprise grade online marketing system that’s built around email marketing. This may seem old fashioned, but it’s still surprisingly profitable. Last year, this £250m company generated an operating margin of 25% on sales of £32m.
Partners with whom dotDigital integrates include Shopify, Magento and Salesforce.
The firm released its half-year results last week, triggering a slide that’s seen the shares fall by 14% in eight days. Is this a buying opportunity, or a sign that growth might be slowing?
I might buy
Sales rose by 25% to £18.8m during the six months to 31 December, while gross profit rose by 20% to £15.6m during the period. However, operating profit only rose by 1.8% to £4.4m.
The difference in growth rates between these two measures of profit was due to a big increase in administrative expenses, which rose by 26% to £11.1m.
Will this extra spending drive future profit growth, or is it a sign of bloat? I’d need to do more research to be sure, but it’s worth remembering that dotDigital has delivered average sales and earnings growth of more than 20% per year since 2012. This is a company that’s delivered on its promises.
Although the shares trade on a forecast P/E of 28, I’d continue to hold and might buy if they dip below 80p.
Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended dotDigital Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.