The software industry has economics few industries can match. Successful companies should have excellent growth prospects, expanding profit margins, and pristine financial health.
• Companies with wide moats are more likely to produce above-average re
turns. But superior technology is one of the least sustainable competitive
advantages in the software industry.
• Look for software companies that have maintained good economics
throughout multiple business cycles. We prefer companies that have been
around at least several years.
• License revenue is one of the best indicators of current demand because it
represents how much new software was sold at a given time. Watch for
any license revenue trends.
• Rising days sales outstanding (DSOs) may indicate a company has extended easier credit terms to customers to close deals. This steals revenues from future quarters and may lead to revenue shortfalls.
If deferred revenue growth slows or the deferred revenue balance begins to
decline, it may signal that the company's business has started to slow down.
• The pace of change makes it tough to predict what software companies will look like in the future. For this reason, it's best to look for a big discount to intrinsic value before buying.
