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Why 10% of my portfolio is in Altium Limited shares

When constructing a portfolio it’s important to only invest big chunks of your portfolio into shares you think can actually beat the market convincingly.

For me, Altium Limited (ASX: ALU) is one of those shares, that’s why 10% of my portfolio is currently in Altium shares. Just to be clear, I didn’t invest my 10% portfolio allocation recently, I’ve held my Altium shares for a long time and the share price has grown strongly. However, I’m happy to continue holding Altium shares for a long time to come.

Altium is an electronic PC-based design software provider for engineers to design printed circuit boards. Here’s why I’m so confident about Altium’s future growth:

Clients

The world of technology gets more complex every year, which is why Altium has an impressive list of clients. Some of the major ones include BAE Systems, BMW, Boeing, Bose, Bosch, Chrysler, Cochlear Limited (ASX: COH), CSIRO, Dolby, HP, John Deere, Lenovo, Microsoft, Monash University, NASA, Philips, Siemens and Toyota.

Internet of Things

The Internet of Things is a growing phenomenon where almost every device is connected to the internet and ‘talking’ to each other. Think fridges, air conditioners, heaters, TVs, cars and so on.

Altium says that modelling, digitalizing and integrating all objects and processes associated with the design and realization of smart products is critical for increasing the speed of innovation.

Financials

Management have done a wonderful job of doubling revenue from US$55.1 million in FY12 to $110.9 million in FY17. Management have predicted that Altium can get to US$200 million revenue by 2020, which may include a contribution from future acquisitions.

A wonderful trait of software businesses is that once they have developed the software it doesn’t cost much to roll out the product to more customers. This leads to higher profit margins as the business grows.

In FY17 the net profit before tax (NPBT) margin grew from 26% to 27% and the earnings before interest, tax, depreciation and amortisation (EBITDA) margin grew from 29.3% to 30%. Growing margins combined with strong revenue growth should be a major boost to the earnings per share (EPS).

Altium also increased its operating cash flows from US$14.1 million to US$35.9 million in FY17 and boosted the balance sheet by having US$44.3 million in cash and equivalents at the end of the year compared to $38.1 million at the end of FY16 and no major long-term debt to speak of.

Outlook

Altium believes the long-term outlook of its business is good. The growth of smart connected devices will continue to grow the business for the foreseeable future.

Management expect to grow the reported EBITDA margin steadily and aim to reach 35% or better by 2020.

Altium will continue to look for new partnerships and acquisition opportunities that should boost the business and product offering.

Foolish takeaway

Altium is currently trading at 37x FY18’s estimated earnings with an unfranked dividend yield of 1.73%. I would be careful about ploughing a lot of money into Altium at today’s price because there’s a lot of growth factored in. Altium may not beat the market over the next six months, but I’m confident it will soundly beat the market over the next five years, which is my minimum investment time frame.

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Motley Fool contributor Tristan Harrison owns shares of Altium. The Motley Fool Australia owns shares of Altium. 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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