Why the tech industry is a unique opportunity for investing

There are some generalisations you can make about certain sectors.

Retail is a cutthroat world and hard for most companies. Healthcare offers defensive and growing earnings.

I think the tech industry offers investors a unique and exciting opportunity.

Tech shares shouldn’t be seen as exciting just because they’re ‘new-age’ technology, but rather because of the wonderful economics they can provide.

If a Harvey Norman Holdings Limited (ASX: HVN) store wants to sell a new table it has to buy the table from its supplier, ship it to the store, pay the rent for its place in the store.

If Xero FPO NZX (ASX: XRO) is going to sell a new subscription to a business, there are virtually no additional costs. It has already developed the software, therefore the new revenue falls straight to the bottom line.

It’s the quick, easy, cheap distribution that makes it so easy for these companies to expand quickly too. They require very little capital to set up and grow, except for the data centres, servers and research & development.

Xero grew its gross margin from 75% to 80% for the first half of its FY18. There are very few companies on the ASX that have such a high gross margin.

It’s a similar story for Class Ltd (ASX: CL1). The business has already developed its software and only needs to make small adjustments each year. Class grew its earnings before interest, tax, depreciation and amortisation (EBITDA) margin from 44.5% to 48.4% in FY17, which is a very high EBITDA margin.

Altium Limited (ASX: ALU) is another good example of strong margins, it has reached an EBITDA margin of 30% in FY17.

Growth and margins are one thing, but there’s more to like about a lot of technology shares.

A lot of the businesses I’ve mentioned so far are described as software-as-a-service (SaaS). This means the customers of the service pay a regular subscription amount.

This has two wonderful effects. First, it creates extremely regular cashflow for the software company. Second, it leads to very high retention rates with the ongoing contract and improvements to the product.

Gentrack Group Ltd (ASX: GTK), Hansen Technologies Limited (ASX: HSN) and WiseTech Global Ltd (ASX: WTC) are just three of many other software options that could be strong market beaters.

Foolish takeaway

I’m a fan of all of these software shares, but you need to be just as picky about the price you pay to get good value. At the current prices I’d only be interested in Class and Hansen.

The hottest software stock of them all could be this Aussie company.

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Motley Fool contributor Tristan Harrison owns shares of Altium. The Motley Fool Australia owns shares of Altium, Class and Hansen Technologies, WiseTech Global, and Xero. The Motley Fool Australia has recommended GENTRACK FPO NZ. 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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