There's Always Upside in the Software Industry

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

The software industry seems to always offer compelling investment opportunities, as many niches still remain untapped. Aci Worldwide (NASDAQ: ACIW), Adobe Systems (NASDAQ: ADBE) and Intuit (NASDAQ: INTU) are three companies that have successfully established in the segment, grasping substantial market shares. Going forward, these firms hold various growth catalysts that should boost earnings and stock prices. Let´s take a closer look at them and try decide if they comprise wise long-term investments or not.

Payments that pay out

ACI Worldwide and its subsidiaries develop, market, install, and support software products and services that enable electronic payments in more than 35 countries. Despite some managerial missteps in the past, the company now seems poised to grow. International markets provide the most opportunities, while the U.S. market looks too mature already. In fact, overseas markets and the acquisitions of S1 and Online Resources have and will most likely continue to create synergies and drive revenue growth in the upcoming years.

The company's main product is BASE24, a collection of electronic payment software products used by banks (about one out of five major global banks) and payment processors like Visa, American Express and Mastercard. The embedded nature of this software, combined with high switching costs, create high client stickiness that is evidenced by the firm's long-lasting customer relations.

In addition, the annuity-like nature of Aci´s revenue stream and the minimal capital expenditures required to maintain its products have provided it with steady cash flows. (Morningstar) This strong cash position should enable the firm to pursue growth through diverse avenues, including international expansion and acquisitions.

Expected to deliver an average annual earnings per share growth rate around 20% over the next five years while trading slightly below industry average valuations, this stock looks pretty attractive for long-term investors and I would recommend BUYING.

This picture cannot be photoshopped

Adobe Systems provides graphic design, publishing, and imaging software, leading the industry in terms of innovation and brand-strength, which helps it create strong network effects and high switching costs amongst creative professionals. However, “competitors offered cheaper alternatives, so when Adobe stumbled with prolonged and erratic upgrade cycles, revenue and user growth slowed.” (Morningstar)

As many analysts highlight, Adobe's future is in the cloud; the transition of its business to the cloud should help solve the aforementioned problems by offering shorter upgrade cycles and allowing the company to respond more quickly to evolving user demands and needs. Moreover, this migration will come coupled with a new subscription model that will replace the one-time payment paradigm. The benefits of this particular strategy stem on the recurring nature of the revenue it generates and the possibility of more deeply understanding customer trends. In addition, more affordable fees will help attract new customers that wouldn´t have been able to access these products before. Although margins are already above industry averages, this model should help further widen them.

Trading at about 31 times its earnings (a 17% discount to the industry average) while offering a moated brand and compelling growth prospects, I’d recommend BUYING and holding on to Adobe’s stock.

Follow your intuition

Intuit provides business and financial software solutions to both individuals and businesses. Its products aim to simplify the management of small and mid-sized businesses, payroll processing, personal finances, and tax preparation and filings. Although the industry is highly competitive, Intuit's wide product offering provides it with an important edge over its peers as it cannot be matched by any single competitor. Moreover, high switching costs have also helped the firm to dig a wide moat around itself, keeping competitors lagged.

Despite its size (its market capitalization reaches $17.5 billion), I believe that there is still room left for growth. With a massive user base, cross-selling capabilities will continue to drive growth in the years to come. The incursion into new segments such as online banking and healthcare should further widen its customer base.

By continuously incorporating its clients' demands to its products, the company managed to keep ahead of its competition. Going forward, this feature will help it penetrate new markets and create region or country-specific products.

Trading at 21 times its earnings with almost half of the industry average valuation, the company offers compelling growth prospects, above average margins and returns, a strong growth story, and very little debt. I’d recommend BUYING Intuit's stock for the long-term.

Bottom line

Above I have reviewed three companies within the application software industry that offer strong business models and brand names. They also plenty of growth catalysts for the years to come. The increasing use of the Internet worldwide and decreasing costs for both the companies and their customers portray a highly encouraging outlook. As I wouldn't like to miss out on a buying opportunity, I'd add all three of them to your long-term portfolio and just prepare to enjoy the upside.

Victor Selva has no position in any stocks mentioned. The Motley Fool recommends Adobe Systems and Intuit. The Motley Fool owns shares of Intuit. 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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