The continuing theme of this column is to discuss the value of cash flows and income. From my perspective, personal investors should focus on scaling down their exposure to risk in a way that allows them to maintain exposure to predictable cash flows over time. Be these cash flows be through dividends, income distributions, or coupon payments, the predictability of these payments makes for an extremely valuable return in the form of peace-of-mind.
However, this pursuit of stability is inherently at odds with specific investment strategies or sectors, in that is limits the ability of an investor to aggressively pursue capital gains in their portfolio. This would suggest that personal investors would need to shy away from the traditionally more aggressive sectors, such as technology and exploration.
While this is partially true, I’m going to use this article to explain how it is that investors can make slight adjustments to the types of companies that they hold within an aggressive sector like technology, in order to maintain their exposure to the attractive returns of the sector with a considerably more stable position.
Software as a service is a concept that has been around for a while now. Companies that provide these kinds of solutions will, instead of earning revenues from 1-time sales, generate returns through subscription packages. These packages will generally provide the subscribers with complex solutions that are continually being adjusted to accommodate a changing environment. From there, subscribers will have access to continuing support, and customization options.
This means that the software company is able to create new value for the customer throughout the value chain by offering more and more services to the client. As the client takes on more services, they become more engaged with the company, and even further value is create. This means that, as investors, we make more money. However, it also means that the company requires additional inputs to create a more robust platform, and to also employ teams to both deliver and improve service levels.
As an investor, we want to balance the risks and returns associated with software as a service as a function of sustainability and growth. On the one hand, the more value we create for customers, the further dependent upon our product they become. However, the more value we create, the more capital we require to sustain that product. So how do we generally get an understanding of what kind of consumer reliance and growth potential we have? R&D expenses are a good place to start, because they demonstrate how aggressively the company is expanding its product line.
As new services are introduced from the R&D department, we can expect to see new value generated from each consumer. Alternatively, we can look at what amount of revenue is being generated from billable hours. Generally, the more billable hours that clients are requiring, the more customized their solutions are, and the more integrated they are with our service.
As investors, the main deliverable from investing in software service, as opposed to traditional technology, is that we gain access to greater stability, and even some distributions. Integrated consumers and opportunities for scaling platforms allow for a more controlled technology company. This is as opposed to the traditional roller-coaster, for which the industry is better known.
