Why it makes sense to invest in ASX tech shares

I think it makes a lot of sense to invest in ASX tech shares. Names like Pushpay Holdings Ltd (ASX:PPH) offer a lot of growth potential.

ASX tech shares

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

I think it makes a lot of sense to invest in ASX tech shares.

I'm not saying that just because technology is 'cool'. I think the businesses that predominately offer technology have inherent advantages that many other sectors simply don't have.

Commodity businesses have to hope that their customers will continue to need more product at a similar or higher price. Banks are heavily reliant on a good economy and they are (rightly) under heavy regulation. Insurers seem to get smashed every few years by a natural hazard event. And so on.

Cheap replication of software

ASX tech shares don't have a lot of major costs once the software is developed. Some businesses have very high gross profit margins. For example, Xero Limited (ASX: XRO) reported a gross profit margin of 85.2% in its FY20 result. When the gross profit margin is that high, it turns a lot of the revenue from new customers into profit at the earnings before interest, tax, deprecation (EBITDA) level.

Once an ASX tech share like Xero, Pushpay Holdings Ltd (ASX: PPH) or others have developed the software, it can be replicated very cheaply and rapidly. If Tesla wants to sell another car, it needs to manufacture it and ship it. A software business can just instantly distribute it over the internet. It makes it very easy to grow the business at a rapid rate.

A business like Pushpay – which offers tools for electronic donations for US churches – is very attractive. It can sell its product to any church in the US whilst utilising its existing software. A wonderful business like A2 Milk Company Ltd (ASX: A2M) has had to spend a lot of effort to build up its logistics network in the US. A2 Milk has to ship physical products to customers unlike many software businesses.

Pushpay was very successful at improving its profitability in FY20 with its gross profit margin rising by five percentage points from 60% to 65%. Pushpay is aiming to double its earnings before interest, tax, depreciation, amortisation and foreign currency (EBITDAF) in FY21.

Software as a service (SaaS)

Not only do the best ASX tech shares offer rapid growth and high profit margins, but they also have quite sticky revenue with their existing customer bases. Perhaps they could be called defensive ideas. 

A client can't quickly switch from Xero. It would take a lot of time (and therefore money) to be trained up on a new system. Plus, if the ASX tech share's software is really good, then the client wouldn't even want to leave.

A business like Altium Limited (ASX: ALU) is another good example of this. Every year it materially builds its subscriber numbers and this helps grow Altium's revenue.

I like ASX tech shares that are able to offer a product that is regularly improved. Altium regularly updates its software. The SaaS model means that software companies can expect regular annual (or even monthly) cashflow from their clients which will continue for the foreseeable future.

ASX tech shares I'd buy today

There are plenty of ASX software businesses that look a bit bubbly to me. However, there are also others that look good value such as Pushpay and Citadel Group Ltd (ASX: CGL).

I also have my eye on names like Kogan.com Ltd (ASX: KGN), Redbubble Ltd (ASX: RBL) and even BetaShares NASDAQ 100 ETF (ASX: NDQ). However, whilst these names have done very well since the COVID-19 crash, it's hard to say if they're good value because it's difficult to know if the shift to online is somewhat temporary (in the shorter-term) or permanent.

Tristan Harrison owns shares of Altium. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Altium. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of BETANASDAQ ETF UNITS, Kogan.com ltd, and Xero. The Motley Fool Australia owns shares of and has recommended PUSHPAY FPO NZX. The Motley Fool Australia owns shares of A2 Milk. The Motley Fool Australia has recommended BETANASDAQ ETF UNITS, Citadel Group Ltd, and Kogan.com ltd. 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 Scott Phillips.

More on ⏸️ Growth Investing

share price gaining
⏸️ Growth Investing

2 stellar ASX growth shares rated as buys

Analysts think these ASX growth shares are in the buy zone...

Read more »

A woman smiles as she sits on the bus using her phone and listening to music through headphones.
⏸️ Growth Investing

2 ASX growth shares analysts rate as buys right now

Check out these top growth shares...

Read more »

A man holds up his hand with 3 fingers up
⏸️ Growth Investing

3 excellent ASX growth shares named as buys

Analysts rate these ASX growth shares highly right now...

Read more »

white arrows symbolising growth
⏸️ Growth Investing

2 growing ASX shares that analysts rate as buys

Looking for growth options? Here are two highly rated shares...

Read more »

chart showing an increasing share price
⏸️ Growth Investing

2 excellent ASX growth shares named as buys

These growth shares could be in the buy zone...

Read more »

rising asx share price represented by stack of coins with green shoots on top
Share Gainers

The Australian Ethical Investment (ASX:AEF) share price is up 124% this year!

Let's take a closer look.

Read more »

A smiling woman holds a bunch of flowers, indicating growth
⏸️ Growth Investing

2 outstanding ASX growth shares named as buys

These growth shares could be in the buy zone...

Read more »

Three young nerds dressed in suits with thinking caps and lightbulbs
⏸️ Growth Investing

3 excellent ASX share ideas for investors this week

Here are three top ASX share ideas...

Read more »