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3 world-beating ASX small caps to buy today (Part II)

This is the second article in a three-part series featuring high-quality ASX-listed software businesses. In part one, I wrote about Objective Corporation Limited (ASX: OCL), a founder led document management software business that serves the public sector.

Integrated Research Limited (ASX: IRI) sells high volume monitoring, diagnosis and reporting software. Its Prognosis product saves money for companies by reducing outages and improving customer service. This explains why Integrated enjoys 95% customer retention rates.

Prognosis is used by 1,000 organisations in over 60 countries and boasts high profile customers such as Visa, Mastercard, American Express, Citigroup and Dell. In total, overseas customers accounted for 95% of group revenue in 2015.

Industry structure

Prognosis has a range of uses including managing online payments, IT and telecommunication networks, call centre systems and EFTPOS. Demand for this type of product is likely to grow in an increasingly connected world, which bodes well for Integrated.

The company also benefits from a favourable competitive environment, with competitors generally falling into one of the following three categories.

  1. Would be customers that have developed an in house solution which is often inferior to Prognosis and does not work across multiple systems.
  2. The major software houses, but performance monitoring and diagnosis software is not their core competency.
  3. Other niche providers but Integrated manages to maintain a technological advantage over these competitors due to its strong commitment to R&D.

Strategy

Management is aiming to grow the business through a four pronged strategy of introducing new solutions, effective marketing, regional growth and strategic partnerships. Like all the companies in this series, management understands the importance of investing in R&D to maintain and extend product leadership and in 2015 R&D spending was 18% of revenue.

Another key factor in the company’s success has been the continuing transition from a one-off license fee structure to a recurring one. 85% of license fee revenue is now recurring plus Integrated also receives an annual maintenance fee.

Valuation

Integrated has a market capitalisation of $382 million and had $7.97 million in cash with no debt at the end of last year. Despite a disappointing profit result for the first half of 2016 characterised by rising sales and marketing costs, management have guided for improved earnings for the full year.

Unlike Objective, Integrated does not expense all its R&D spend, but the amount that is capitalised is generally covered by depreciation and amortisation. Therefore, last year’s net profit after tax (NPAT) of $14.25 million is a fair reflection of the underlying performance of the company.

Putting this altogether, Integrated currently trades on a trailing enterprise value-to-earnings multiple (EV/E) of 26. Assuming last year’s dividend is maintained, the stock also comes with a dividend yield of 3.4%.

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Motley Fool contributor Matt Brazier has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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