U.S. Markets closed

2 Top SaaS Stocks to Buy Now

Keith Noonan, The Motley Fool

Software as a service (SaaS) has emerged as a preferred business model for many of the biggest players in the tech sector. It's a trend that's shifting operations to the cloud, cutting down on the need for local storage and computing hardware, and establishing recurring-revenue streams that give provider companies steady and dependable sales bases.

The cloud-based service model also tends to be highly scalable at relatively little cost once the core product is in place, creating opportunities for big earnings momentum as subscriber bases grow. That's a quality likely to be of great interest to investors. Read on to see why IBM (NYSE: IBM) and Shopify (NYSE: SHOP) are stocks that could position you to benefit from the growth of SaaS.

A connected web of clouds with power buttons on them.

Image source: Getty Images.

IBM

IBM is going through a transformation. As its legacy hardware business fades, the company is becoming increasingly software-centric and focusing on analytics, security, mobile, and social services. Big Blue groups these ventures together in a segment it calls "strategic imperatives" and sees them as the growth drivers that will position the company for long-term success.

Declines for its legacy hardware and software businesses have put a hurting on revenue in recent years, but the IT giant is making some laudable progress with its transition. For the December-ended fiscal year, strategic-imperatives revenue increased 11% year over year on a currency adjusted basis to reach $36.5 billion -- or roughly 46% of total sales. Cloud-services revenue increased 18% on a constant-currency basis to reach $10.3 billion. Most of the company's growth businesses tie into the SaaS model, setting up the potential for an expanding base of dependable recurring revenue -- particularly if it's able to continue creating attractive synergies across its product ecosystem.

While the company's business is in transition, IBM's position as a leader in the enterprise technology space appears to be fairly steadfast, with its cloud platform being used by each of the world's 10 largest banks, nine out of 10 of the world's largest retailers, and eight of the world's top-10 airlines. That's a customer base that positions Big Blue to capture ongoing growth in cloud services. The company's early leadership position in artificial intelligence should work to bolster the value of its software offerings as well.

These growth businesses still require significant investment, and this means that there are likely to be pressures on its margins in the near term, but this spending should help the company remain competitive in enterprise tech and create the chance to capture long-term growth in the industry. IBM stock also comes with a big dividend component that will likely make riding out potential bumps along its road to reinvention easier to stomach. Shares yield roughly 3.7% at today's prices, and the company's 22-year history of consecutive annual payout increases suggests its dividend will continue to grow.  

Trading at roughly 13 times forward earnings and packing a substantial dividend, IBM looks like a smart value play in the SaaS space.

A miniature shopping cart on top of a mobile phone.

Image source: Getty Images.

Shopify

For risk-tolerant investors seeking potentially explosive gains, Shopify is a company that's worth adding to your portfolio. The company specializes in delivering customizable e-commerce platforms for small and medium enterprises (SMEs) and has a runway for growth that could translate to stellar long-term stock performance. While brick-and-mortar will continue to make up the lion's share of retail for the foreseeable future, it's clear that the online space is where the real growth is. Companies that can tap into and add to this momentum have huge opportunities ahead. 

The U.S. Department of Commerce reports that e-commerce revenue grew 15.5% in the October-ended quarter, but even with that healthy growth, online sales still accounted for just 9.1% of total retail sales. As online selling continues to expand at a rapid clip, Shopify is positioned to benefit in multiple ways. Having a robust online presence will become increasingly essential for businesses, which should have a beneficial impact on demand for the company's e-commerce platform.

Shopify last reported its subscriber count in August and touted the fact that over 500,000 businesses were using its SaaS platform -- up from 300,000 merchants just a year earlier. The company also announced that it had grown its subscriber base at an average annual rate of 74% since 2012. These growth figures are plenty impressive, but, even more important, its subscriber base remains on track for rapid and ongoing expansion. 

Shopify estimates that there are roughly 10 million SMEs in its core geographic markets, suggesting that the company has tapped into roughly 5% of its current addressable market. Worldwide, the number of potential SMEs that could benefit from its online sales platform expands to 46 million, so there could be room for even more growth down the line. Shopify is even finding success in building relationships with large enterprises and brands, with companies including Anheuser-Busch, Tesla Motors, and Red Bull using Shopify as a merchandise sales portal. 

Once merchants begin using Shopify's services, the generally high quality of its software and cost of switching to a competitor make it likely that they will remain within the company's ecosystem. The service provider has already managed to secure partnerships with internet giants including Amazon and Facebook, and the scant number of competitors in its space puts the young e-commerce company in position to capture much of the overall industry's subscriber growth in its core geographic markets.

In addition to subscription revenues, Shopify also takes a cut of each sale made on its platform -- setting up a dynamic that helps the company benefit from the success of its customers. Thanks to growth for its subscriber base and total merchant sales volume, the company has managed to increase its trailing 12-month revenue more than 370% over the last three years and deliver 72% year-over-year sales growth in its most recently reported quarter.

The long-term benefits created by strengthening its platform have, thus far, prompted the company to pursue infrastructure improvements and customer acquisitions over profits, but a promising earnings picture is emerging and on track to get better with time. Shopify is valued at roughly 13 times forward sales estimates, so it certainly has big expectations to live up to. However, its huge addressable market and leadership position in its niche both point to a long runway for growth -- and one that could prove very rewarding for investors.

More From The Motley Fool

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Keith Noonan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon, Facebook, Shopify, and Tesla. The Motley Fool has the following options: short March 2018 $200 calls on Facebook and long March 2018 $170 puts on Facebook. The Motley Fool has a disclosure policy.