How to Value Cloud Companies

Last week I professed my ignorance on how to value cloud companies using the specific example of Salesforce (CRM):

http://discussion.fool.com/questions-about-salesforce-crm-323435…

Using a Bert Hochfeld article on Seeking Alpha about Salesforce, I confessed that the methodology of valuing such companies was more than a little beyond my comfort level.

As coincidence would have it, today another article appeared on Seeking Alpha by Mark Gomes addressing this very issue helpfully titled “How To Pick Cloud Software Stocks”. It addressed the very area of difficulty I was having and I found it extremely helpful.

This article is written for anyone who wishes to profitably invest in cloud software stocks but haven’t spent their careers in the software industry. I will discuss a key characteristic of these seemingly high-risk companies. If successful, my explanation will help you understand why these companies only appear overvalued.

Software companies gain value as they build ever-bigger bases of customers. These customers buy more software (or maintenance on their existing software) year after year.

That “recurring” revenue doesn’t require the same sales/marketing effort as it took to attract the initial business. As a result, recurring software revenue is very profitable.

This is what makes cloud software companies so valuable. If you missed out on Salesforce.com (NYSE:CRM) years ago, this is likely one of the reasons why.

Read the entire article at http://seekingalpha.com/article/3997825-pick-cloud-software-…

Anyway, I figured if this article helped me understand this concept better it might help others too, so I’m passing it along.

Matt
MasterCard (MA), PayPal (PYPL), and Verizon (VZ) Ticker Guide
See all my holdings at http://my.fool.com/profile/CMFCochrane/info.aspx

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