Should You Invest in These Cash Cows

Nihar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Software is one of the most common types of products where the cost of selling one versus 1,000 is fairly marginal. There is very little replication cost for software as opposed to manufacturing physical products. Offering services can fall in the middle if it requires employees, but can also be an automated service or access to a software.

These types of businesses come in many varieties, but when they first start transitioning or growing into this new kind of business, it can mean great things for the stock. With the potential for economic growth here in the U.S. and a resurgence in Europe, the idea that a company can sell more without incurring a subsequent higher cost is a tantalizing one. Nothing ever proves this simple or ideal, but it is definitely a start.

Why copy, when you can email?

I wonder if any children under the age of 13 can remember Xerox (NYSE: XRX), because even in the 90s, the push to call it photocopying was well underway. Now the idea of paper copies is headed into obsolescence and absurdity. Even government documents like taxes can be submitted online. Xerox has not slipped into the black hole with the clay cylinder and papyrus makers of old. It has moved strongly into services.

E-discovery is one of the most interesting services, which is expected to grow significantly over the next few years though Xerox is in enterprise e-discovery only. E-discovery is a part of the discovery process in legal proceedings and is becoming increasingly important as a part of pre-trial preparation.

The role of e-discovery will only expand, and this is a masterful stroke by Xerox if it wants to take multiple bites into the whole “big data” apple. E-discovery is part of that poorly defined concept, and anyone familiar with the U.S. legal system knows it involves vast amounts of money.

It is worth looking into the other services that Xerox is in and plans on entering, including digital document management and other printing services. The company is also entering the e-learning business. Services offer higher margins, and even if the top line doesn’t grow, better margins mean a fatter bottom line.

Xerox has a bit more debt than I would like to see, with $8.5 billion in debt versus $993 million in cash. The company sports almost a 2.5% dividend, which is small considering the company will largely remain outside the spotlight in the near-term. Consider that its three-year return is 18%, which is dismal given the last three years. Profit margins are hovering around 5%, and a key sign of success will be for this number to increase.

Adobe Systems (NASDAQ: ADBE) is a software company moving to software-as-a-service model, and while it is a little behind the curve, it is never too late. As Adobe increases its subscriber base, it will not be incurring proportionally increasing costs. Other than offering the bandwidth and capacity, it takes the same number of people to roll out features to 100 people as it does to 1 million people.

A subscription model offers consistency to Adobe’s revenue. Instead of rolling out a new version, it has a consistent revenue stream and can release features as they are ready. At least that is what I would hope they do. The stability is not trivial. Imagine the share price impact if the company had to push back a release of the next version, and pushing expected revenue to the next year while replacing it with nothing.

Adobe has received a lot of attention as it has reported solid progress in subscriber growth. The company does seem more expensive than Xerox. With Xerox out of the limelight and a story that will unfold over the next few years, it is more attractive to me than Adobe, which is in focus right now. A substantial decline might be a good entry point for Adobe, but Xerox is fine to jump into now. Just keep in mind that it will decline if the overall market declines. That shouldn’t scare you away.

Low cost and repeatable

Activision Blizzard (NASDAQ: ATVI) is coming out with a free-to-play collectible card game based in the Warcraft universe. I know from firsthand experience that these games can be maddeningly addictive if done right. With collectible card games, you have opportunities to sell decks, special cards, and the villainous booster pack.

Unlike traditional DLC, which can cost quite a bit to develop and people tend to buy once, the micro-transactions in a collectible card game make each individual into an unlimited buyer. You can never have enough boosters.

Booster packs cost the company nothing and can bring endless joy to shareholders, though being priced at $1 per pack seems very reasonable. Once complete, these games are not as hard to maintain or add to as World of Warcraft. Turnover is high, but so is the longevity of the product.

The number of cards and gameplay mechanics available can be expanded over time to keep the game fresh, and its casual nature can keep people playing longer at a lower level of intensity. Look no further than Magic: The Gathering to understand the variety and longevity of these type of games. Free-to-play is the direction that gaming is going in, and it is nice to see Activision Blizzard getting involved.

The company has no debt and a lot of cash, but growth concerns me. This free-to-play game offers interesting possibilities, but I would only keep an eye on it. I want to see how the game performs after the beta is over, and then I will consider my options. I get the sense that World of Warcraft’s good years are behind it, and that is a concern.

Conclusion

Xerox seems like a good choice if you have the patience to wait. It probably will not explode, but consistent gains are possible. Adobe would have been a good choice a few months ago, but now waiting for a better entry point seems like a better idea. Activision Blizzard was a favorite of mine, but I am not sure what will keep growth moving along. You will have to wait for Hearthstone, Ghosts, and Destiny to determine if Activision Blizzard can remain the great company that it has been in the past.

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Nihar Patel has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard and Adobe Systems. The Motley Fool owns shares of Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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