We're all aware of the stellar returns that the big name tech stocks have delivered to shareholders recently. Investors who bought into market darlings like Afterpay Touch Group Ltd (ASX: APT), WiseTech Global Ltd (ASX: WTC) or Altium Limited (ASX: ALU) a few years ago when shares in all these companies were trading under $5 are sitting on a goldmine right now. Ask these investors how they knew all these companies would grow into the tech superstars they are today, and I'm sure they will happily regale you with stories of their supreme stock-picking prowess.
The truth is that it was probably more luck than skill.
But this does still go a long way towards demonstrating how important it is to effectively time the market and invest for the long term. There's not much point buying into growth stocks once they've already blown up – their biggest returns are already behind them. Instead, the savviest investors are on the prowl for the next Afterpay or Altium.
Searching out these diamonds in the rough can be a risky enterprise. Plenty of promising companies never make it. This is especially true in the tech space, where the next great idea can render a whole industry obsolete. Plenty of bright minds invested in minidiscs and Betamax, but it was Apple shareholders who became millionaires.
So how do you spot tomorrow's tech success stories?
There's no denying you'll need a little luck on your side. But there are still signs to look out for that can help you identify which companies are setting themselves up for longer-term success, even in the fickle tech industry. For example, a high rate of returning customers is a positive signal, as is locking in recurring revenues through subscription-based services.
Recurring revenues generated through subscriptions show that customers have faith in the longer-term viability of the company's products and services. From a business planning perspective, predictable rates of cash flow growth allow a company to budget more effectively and manage its investments in research and development to defend its intellectual property from competitors.
Two young tech companies that are succeeding on this front are ELMO Software Ltd (ASX: ELO) and LiveTiles Ltd (ASX: LVT).
ELMO is an IT company specialising in the development of solutions for human resources. It produces a suite of cloud-based software to help their business clients with payroll and people management.
At the time of writing, ELMO is yet to release its FY19 full year results, but in its preliminary report released to the market in the last week of July it announced cash receipts of $45.1 million for FY19, an uplift of 60% on the prior year. Crucially, active customers increased by 30% on the prior year to 1,341, and annualised recurring revenues jumped 48% to $46 million.
LiveTiles operates in a not so dissimilar space to ELMO. However, rather than focussing on HR, LiveTiles helps business clients boost their employee engagement by creating internal dashboards, intranet portals and collaborative online working environments.
LiveTiles recently announced that its annualised recurring revenues had surged 167% in FY19 to $40.1 million. Its stated goal is to reach $100 million in annualised recurring revenues by 30 June 2021. This is a lofty ambition, but given the company's current rate of growth it's not hard to see it hitting that target.
Foolish takeaway
Tech stocks are risky investments, and neither ELMO nor LiveTiles are guaranteed to succeed in the long run. But by locking in streams of recurring revenues, both companies are setting themselves up for success – and they may even grow to become the next Altium.
