For investors trying to add tech stocks to their portfolio, choosing the right company for growth can be like trying to catch lightning in a bottle. Developments in the tech space can often move so quickly that it's difficult to work out whether you're onto a winner, or a lemon.
So let me do the legwork for you.
Here are two standout Australian tech companies with strong business models – and both are well positioned to add growth to your portfolio in 2018 and beyond.
- Altium Limited (ASX: ALU)
Altium develops printed circuit boards (PCBs), an integral component to almost all electronic devices. The company is an industry leader in product design and its clients include global giants Dell, Microsoft, NASA and SIEMENS.
Altium forecasts that more than 30 billion smart devices will be connected to one another through the internet by 2020. It terms this interconnected web of devices the "Internet of Things", and expects it to spur demand for ever more complex PCBs. With over 30 years of investment in R&D under its belt, Altium is confident it can cash in on this new trend in tech.
One of the most attractive things about Altium is that it operates a really clean, simple and streamlined business model.
53% of total revenue is subscription-based, which means more reliable earnings projections and less volatility. Altium is growing its list of subscribers faster than any of its industry peers and revenue growth is 2-3x the industry average.
Plus the company is debt-free. All R&D costs are expensed when incurred and interest costs are almost non-existent. Finance costs made up less than 1% of total expenses in FY17.
Altium is globally diversified, with revenues divided up between the Americas (48%), Europe (32%), Emerging Markets (14%) and Asia Pacific (7%). Pleasingly, in FY17 revenues grew across every geographical segment apart from Emerging Markets, where they remained flat.
In FY17 NPAT increased 22% to US$28 million. Revenues were up 18% to US$ 111 million, which beat Altium's own target by US$11 million, and the company's outlook is for continued double-digit revenue growth.
Altium aims to be the market leader by 2020 and has set an annual revenue target of US$200 million. Given the speed at which it is growing its subscriber pool the safe money is on it achieving its objectives.
Altium is also committed to increasing its shareholder dividend each year, which for FY17 was 23 Australian cents per share. It currently trades at $14, around 49x earnings.
- ELMO Software Ltd (ASX: ELO)
ELMO sells a suite of cloud-based HR software. It provides an integrated platform of modules that that covers the full employee lifecycle from "hire-to-retire". As well as its core HR people management software, it offers products which help to automate recruitment, onboarding, professional development and succession planning, as well as a number of customisable eLearning options.
In December ELMO added a new Rewards and Recognition module to its suite, the first of four modules it plans to develop in-house over the next two to three years. And in November it spent about $10 million to acquire PeoplePulse, an online staff questionnaire system, and LiveSalary, a salary comparison database.
This flurry of activity shows that ELMO is committed to becoming a one-stop shop for all mid-sized business's HR needs. And investors are excited about its prospects – its June IPO was the biggest for a tech company in 2017, and its share price has more than doubled since it listed at $2 to now trade at $5.26.
Admittedly this is more of speculative buy right now, and in many ways ELMO is yet to prove it can deliver sustainable results for shareholders.
The company didn't post a statutory profit for FY17 despite an increase in revenues, but this was due in large part to marketing and IPO-related expenses. Adjusting for the IPO costs and other one-off expenses, including acquisitions, gives a much healthier view of the underlying state of the business: pro-forma EBITDA was $1.2 million and earnings were 42% ahead of the prospectus guidance.
I like ELMO for the same reasons I like Altium.
93% of its FY17 revenue came from subscriptions. These generally last for a period of 3 years and are paid annually in advance. This business model locks in a dependable source of income and gives investors more faith in the company's earnings projections – which are pretty bullish. ELMO forecasts its FY18 pro-forma revenue to increase by almost 32% to $22.4 million.
Plus, like Altium, ELMO also has a clean balance sheet with no debt, which means it isn't burdened with finance costs.
Foolish takeaway
I expect both of these companies to outperform in 2018.
But not only that – with their subscription-based business models and focus on maintaining a debt-free balance sheet, they also set themselves up to deliver sustainable returns to shareholders over the long-term.
