The software world has rapidly embraced ‘SaaS’, or “software-as-a-service.” Also known as a ‘cloud’ offering, the SaaS model underpins the case for almost all of the software stocks to buy at the moment.
Indeed, some of the biggest software stocks in the world have transitioned from “on-premise” models to the cloud. Microsoft (NASDAQ:MSFT) is the biggest, and perhaps best, example. Others haven’t done as well, with IBM (NYSE:IBM) and Oracle (NYSE:ORCL) among the names threatened by cloud rivals while trying to transform their own businesses.
The appeal of the SaaS model is obvious. Gross margins are enormous, often over 80%. Revenue recurs, as opposed to the one-time (if larger) sales booked under the past model.
And once a customer is acquired, it’s difficult for that customer to exit. Indeed, conventional wisdom suggests that SaaS contracts are better than secured debt. Customers, after all, can keep their operations going in a restructuring. They can’t do if they give up on mission-critical software.
The problem at the moment is that the market is not unaware of the value of the SaaS model. Stocks across the sector have soared to record highs, and potentially unsustainable valuations. But there are still software stocks to buy due to their SaaS strength, and investors should start their search with these four names:
Software Stocks to Buy: Salesforce (CRM)
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If an investor is going to own an SaaS stock, one place to start is with the company that brought the model to the mainstream. Salesforce went after Oracle’s dominance in CRM (customer relationship management) software via its cloud model.
Since then, CRM stock has been one of the best in the market. It’s returned 4,750% since its 2004 initial public offering. That’s a staggering annualized return over 25%.
The gains are going to slow going forward, but they’re unlikely to stop. Salesforce still has a massive lead in CRM, though HubSpot (NYSE:HUBS) is trying to chip away. The 2016 acquisition of Demandware moves the company more heavily into e-commerce as well.
To be sure, CRM stock isn’t cheap. But it hasn’t been pretty much ever. This seems a classic case of investors paying up for quality.
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Workday stock is interesting for two reasons. First, the business model is enormously attractive. Workday’s HCM (human capital management) platform is of great value to large enterprises in particular. And it provides a base for steady expansion over time.
The second reason the stock looks attractive is relatively muted performance of late. WDAY stock actually is down over the past year, if by just 0.3%. According to a screen on finviz.com, there are 55 software stocks with a market capitalization over $10 billion. Only four, like WDAY, are negative over the past 12 months, and one of those is pandemic victim Uber (NYSE:UBER).
To be sure, it’s possible concerns around the model explain that poor performance. Competition likely is one of those concerns. But it’s equally likely that WDAY stock will catch up to the myriad other names that have been among the most popular software stocks to buy. Earnings this week proves the point, as the company beat estimates for the second quarter.
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Outside of Microsoft, perhaps no large company has better managed the transition to SaaS than Adobe. Its Photoshop and Illustrator, among other platforms, traditionally were disk-based options.
They are now part of bundles, including Adobe Creative Cloud, that have driven impressive and consistent growth in recent years.
As with CRM, valuation admittedly is a concern. ADBE stock historically didn’t look that expensive, often trading at 30x forward earnings or less. It’s now as 43x.
But with MSFT itself clearing 30x, and CRM over 50x, that multiple on its face isn’t outrageous. And with Adobe’s growth likely to include e-signatures as well, there’s plenty of runway for the company to grow into the steep valuation assigned its stock.
Varonis Systems (VRNS)
Varonis stock is one of the more intriguing Big Data plays out there. The company specializes in so-called “unstructured data” like PowerPoint presentations, documents, and even images. Varonis products both improve security (by controlling access to that data) and allow for analysis and sharing of that data.
It’s an attractive model. What makes it more attractive is that direct competition is limited. Varonis itself wrote in its most recent annual report — as it has for years — that “we do not currently compete with a company that offers the same breadth of functionalities that we offer in a single integrated solution.”
As is the case with other SaaS names, valuation does look stretched. VRNS stock trades at almost 15x trailing 12-month revenue, and the company isn’t yet profitable even on an adjusted basis. But there’s a huge opportunity here, and a market capitalization under $4 billion doesn’t seem commensurate to that opportunity.
Investors looking for software stocks to buy are going to have to pay up, and VRNS looks like one of the better mid-cap options from that perspective.
Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets. He has no positions in any securities mentioned.