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Down 6% in a week, is the Class Ltd share price a buy?

The Class Ltd (ASX: CL1) share price has fallen 6% in the last week. I always like to consider shares when they fall in price, particularly if they’re on my watchlist. I’m always looking for good value investments.

Class is a cloud software provider to self-managed superannuation fund (SMSF) administrators. Here are some of the reasons why I own Class shares and why I’m considering buying more:

Improves efficiencies

Class offers SMSF administrators a lot of powerful automation tools through the power of the internet.

Before Class came along the task of doing the compliance work wasn’t very profitable for accountants. Now it is profitable and this motivates users of the system to stay with Class. That’s how Class has been achieving retention rates of above 99% for the last few years.

Class is constantly adding to its capabilities, which makes its offering even more attractive. A competitor would have to offer a materially better or cheaper product to steal Class subscribers.

Growing market share

It appears that Class is sweeping aside the competition. Class has been growing its market share so much that virtually all the growth of the SMSF market has gone to Class.

When you combine a growing market share with high retention rates you get a very attractive business.

In its latest quarter update to 31 March 2017, Class revealed it grew its number of portfolios by 5,520. Class won’t always be growing at such a fast pace, but with around 23% of accountants saying that they intend or are very likely to move to the cloud there could be a lot of growth in the near-term.

Highly scalable

Software businesses are great because once they have built the software it’s very easy and cheap to distribute it. You don’t need to build more buildings or manufacture more physical products to grow earnings.

Being highly scalable creates very large profit margins and additional revenue should fall mostly to the bottom line.

Risks

At some point a competitor, such as BGL, may offer a genuinely competitive and good-value product. Class would have to fight a lot harder to gain new clients in that scenario.

At some point the AMP Limited (ASX: AMP) portfolios will be taken in-house and Class will lose a decent chunk of revenue. The amount of AMP portfolios stood at 7.2% of annual committed revenue at 31 December 2016.

Time to buy?

Class is currently trading at 55x FY16’s underlying earnings with a grossed-up dividend yield of 1.98%. This is expensive, even with all the growth it’s achieving.

In the medium-to-long-term I think this share price will be justified, however I’d want to buy the shares at a lower price, perhaps around $2.70 for a comfortable margin of safety, particularly as the AMP portfolios could make a dint in revenue.

Until Class shares are at a lower price, I'm looking to buy one of these growth shares.

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Motley Fool contributor Tristan Harrison owns shares of Class Limited. The Motley Fool Australia owns shares of Class Limited. 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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