In my view, the ASX tech stock TechnologyOne Ltd (ASX: TNE) is one of the most compelling businesses on the ASX.
There aren't many S&P/ASX 200 Index (ASX: XJO) shares that have delivered a return of more than 220% in the past five years, but TechnologyOne is one of them, with a rise of 223%.
Past performance is not a guarantee of future returns, particularly when it comes to businesses where the share price has soared in a relatively short amount of time.
If the share price goes too high, the price-earnings (P/E) ratio could reach unsustainable levels. The danger is present in the ASX's leading growth shares, where the P/E ratios have gone well above 100.
However, I think the TechnologyOne share price could still be attractive enough to deliver strong returns.
The ASX tech stock describes itself as Australia's largest enterprise software company, with offices in six countries. It provides global software as a service (SaaS) enterprise resource planning (ERP) solutions which are "available on any device, anywhere and any time and is incredibly easy to use".
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Why I think the high price tag is worth it
The business has an impressive, wide-ranging customer base with 1,300 corporations, government agencies, local councils and universities.
TechnologyOne is growing its annual recurring revenue (ARR) at a very fast pace. The company has brought forward its $500 million ARR goal from FY26 to the first half of FY25.
The ASX tech stock invests heavily in research and development (R&D) to help retain existing clients and attract new ones.
TechnologyOne has an impressive net revenue retention (NRR), which tells us how much its existing customers are paying. If revenue from its existing group of clients grows from one year to the next, the NRR will be above 100%. The company is targeting an NRR of at least 115%.
The company is targeting at least $1 billion of ARR by FY30, which implies a doubling between FY25 to FY30.
But, the business isn't just expecting strong revenue growth. Its profit margin is expected to grow to at least 35% through economies of scale. In other words, as it gets bigger, it's expecting its profit to rise faster than revenue.
According to UBS, the business could generate $238 million of net profit, a doubling compared to the forecast of $118 million for FY24. It's valued at 33x FY28's estimated earnings.
Why could the ASX tech stock deliver a 50% return?
No returns are guaranteed, of course.
If TechnologyOne's profit doubled and the P/E ratio stayed the same, the share price would double.
But I think it would be unrealistic to expect the P/E ratio to stay the same. So, instead of the profit and share price doubling by FY28, I'm going to be more cautious and believe the capital return may be half as strong – a 50% return.
A small dividend could also increase the overall return. According to UBS, the dividend per share could be 44 cents in FY28.
If TechnologyOne can grow its profit before tax by around 20% per annum over the next five years, as UBS expects, I think this ASX tech stock is a compelling buy despite the high valuation.
