2 Fool Articles on SaaS stocks

Brian Stoffel (TMFCheesehead) has been prolific lately. Here are two public Fool articles from him:


But by far the biggest advantage of the SaaS model is that it provides a wider economic moat, or sustainable competitive advantage, by creating high switching costs. Switching costs can range from actual monetary costs a customer faces to move away from a particular product, service, or provider to the time spent or aggravation caused by needing to implement such a change. SaaS models create high switching costs of both varieties.

His 7 recommendations are:
Axon Enterprise (NASDAQ:AAXN)
Zuora (NYSE:ZUO)
Veeva Systems (NYSE:VEEV)
Paycom Solutions (NYSE:PAYC)
Zendesk (NYSE:ZEN)
New Relic (NYSE:NEWR)

He also talks about The PowerShares Dynamic Software ETF, which invests in SaaS companies, has more than doubled the S&P 500’s returns over the past two-plus years.

More importantly, he talks about what to look for in SaaS companies:

To assess whether a company is bringing enough customers in, keep an eye on these three metrics:

Growth in total users: Measuring the growth of users is relatively easy. SaaS companies either publish these numbers in their press releases or mention them in their conference calls. When such growth is present, it shows the SaaS offering is superior to whatever else is available. Sometimes, when the company is sufficiently big, it will forgo such metrics in favor of ARR – a measure of predictable cash flows.

Customer acquisition costs: We also want to know that customer acquisition costs aren’t onerous. If an SaaS company is adding lots of users, it makes sense that sales and marketing expenses will also increase. What’s important is that these expenses grow at a slower rate than jumps in ARR.

Annual recurring revenue (ARR): Why focus on ARR instead of revenue growth? Because of how revenue is recognized. If a salesperson gets a $1,000 bonus for signing on a client who will spend $12,000 over the next year, that’s not a bad deal. But if it occurs one month before the end of a quarter, the revenue statement will only reflect one month’s subscription – or $1,000. On the surface, that looks like a pretty bad deal: the salesperson was paid $1,000 to bring in $1,000. Zeroing in on ARR gives a clearer picture; because that $1,000 is recurring, we can see that the sales money was well spent.

Revenue retention rate (RRR) or dollar-based net expansion rate (DBNE): Both figures measure the same thing: they take all the money that existing customers spent in Year One and compare it to all the money the same group of customers spends in Year Two. By doing this, we wash out the effect that new customers have on revenue and combine the forces of churn (losing a customer) and cross-selling existing customers on new products.

An RRR or DBNE of 100% is a good starting place, because it means that customers are generally staying with a company. What investors should really look for are figures above 100%, which means that not only are customers staying on board, but they are adding more products over time.

And the usual caveat:
As exciting as these investment opportunities may seem, there’s also a fair level of risk involved. Technology and marketplace trends are pointing squarely toward continued growth for SaaS, so many companies in the field have very high valuations. As such, even the smallest sign of weakness or a slowdown in growth can cause their stocks to plummet.

That’s part and parcel of investing in high-growth industries. If you don’t have the stomach for such wild swings – and might be tempted to hit the “Sell” button when such drops occur – investing in SaaS companies might not be for you.

Furthermore, many smaller SaaS companies have yet to become profitable or are only just past the threshold. That’s not without reason, as many of them are investing aggressively in order to capture long-term market share of those reliable-revenue streams. But if an economic crisis were to occur, those companies could be hit particularly hard if business growth decelerates markedly and the investments for further growth don’t bear fruit.

There’s always the risk that larger software players – those that existed long before the onset of SaaS and have troves of cash on hand – could create services to rival those of smaller companies and offer them at lower introductory rates. While that would hurt larger players in the short term, they could raise prices after a few years, assuming they can take enough market share to force smaller competition to fold or to be acquired by others.


On one of the Motley Fool podcasts - they discussed Axon Enterprise (AAXN). They have a monthly recurring revenue model because they store the video produced from the body cameras. Law enforcement is their largest industry vertical.