Proven Quality In Software And IT: Moneysupermarket, FDM And Dotdigital

19th Jun '20 by Jack Brumby

7 comments 4270 reads

The UK tech sector is booming. Tech Nation’s 2020 report shows that investment in this part of the market surged by 44% in 2019 to some £10.1bn - more than the amount spent in France and Germany combined.

So it makes sense to look for investments in the UK-listed Software and IT Services industry group. Here we have 128 listed Software and IT Services companies to analyse. I’ve highlighted three below: Moneysupermarket.com (LON:MONY) , Fdm (holdings) (LON:FDM) , and Dotdigital (LON:DOTD) . I’m sure there is plenty of opportunity in this space though, so other suggestions are appreciated.

Looking at the group in aggregate there is a clear High Flyer profile:

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A lack of traditional value is to be expected in this part of the market. But when you dig down into the Styles, a much more characterful and eclectic picture emerges: for every High Flyer you’re more likely to find a Momentum Trap, Falling Star, or Sucker Stock.

The group begins to come to life now.

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A breakdown of the RiskRatings further confirms that we should tread carefully in this industry. There are high returns to be had, but there is a lot of volatility as well. In fact there are no Conservative stocks, and the large speculative weighting skews the set firmly towards the more volatile end of the market:

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It appears as though fortunes can be both made and lost in Software.

Moat or mirage? Refining the sample

That might in part be because it’s so hard to make moats in this sector. The innovation and evolution is so intense that seemingly incredible bits of hardware and software can soon become obsolete. Today’s high margin must-have can be, by tomorrow, just another binned Blackberry.

High profit margins tend to have an expiry date - if you’ve found a good meal hungry rivals will muscle in.

Some companies can defy gravity and maintain high margins for great periods of time though - and it is these companies that go on to create a tremendous amount of value for their stakeholders.

If an economic moat is a durable competitive advantage, we can think of that in two dimensions: there’s depth (how much money the firm can make from its…

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Macro

19th Jun '20

Thanks for the excellent review, Jack.

I hold AUTO.L, RMV.L and MONY.L currently, plus SGE.L not mentioned above.

If you like the relatively high growth prospects, low capital requirements and high relative earnings safety that comes with subscription based models - but dont like the bumpy ride of some individual stocks then the iShares ETF IITU.L might be worth a look-see (although not at these extended prices, obvioulsly). This gives exposure to the far larger set of USA S&P500 IT companies.

https://www.ishares.com/uk/ind...

WarrantStar

Jack. Thanks for yet another informative article. I invest in this sector quite a lot. Towards the more speculative end of the spectrum, I like IDOX. The forecast to 31/10/2020 is for 2200% EPS growth, and it's in a bit of a turn around situation.

As far as FDM is concerned, I believe that the moat arises because they train all their "mounties" ( consultants ) themselves from scratch, and the quality of their selection procedures and training is considered to be very good.

Please can you tell us what the "Professor score" is about that you mention for MoneySupermarket ?

Jack Brumby

Thanks re. Idox (LON:IDOX) - I've probably excluded some interesting turnaround situations given the long term profitability criteria I used... I'll check out the StockReport.

Professor scores - maybe this is just a phrase I use in my own head! I thought it was more of a thing... I just mean the F-Score, Z-Score, and M-Scores, which I believe were all formulated by various professors based on their academic studies.

Cuddlesticks

22nd Jun '20

Thank you Jack for a great analysis. I enjoyed reading through your structured approach. I hold Fdm (holdings) (LON:FDM) and having spent 7 years working in a big 4 consulting practice my thoughts around their competitive positioning are:

Strong UK business is driven by public sector. Their professional approach, ie recruitment and training of mounties, will distinguish them from other low cost providers and contractors, whilst remaining less expensive than competition from big 4, Accenture, IBM etc (who have more expensive overheads and greater margin pressure)
For me, their success suggests they have strong relationships with key decision makers in key markets e.g. UK Government. From my experience, this can be a critical (although vulnerable) competitive moat, as it helps steer the firm through formal competitive tendering processes. The business size suggests they're not relying on just one or two 'rain makers' to generate business though
Reliance on UK Government leaves them exposed to spending cuts but perhaps this should be weighed against the secular digitisation trend governments must address
Generally, consultancies enjoy good margins but massively benefit from scale. The non government business will be a leveraged play on the economy
The business in Asia and Australia continues to be sub scale and struggling with profitability. This concerns me a bit as I can't see progress and I hope the business isn't driven by one or two senior managers who simply decided to re-locate there (as opposed to readily accessible market opportunities)

On balance I'm happy to hold this investment as it continues to publish robust results given the economic climate, but I'm wary of the potential downsides from Government spending cuts and a prolonged economic down turn.

Berksbee

I'm with you on Idox (LON:IDOX) Warrant. I own it and somehow missed the news of the forecast. Note it got short shrift from Paul the other day too.

23rd Jun '20

Postscript - added to my holding on the back of it

iwright7

23rd Jul '20

Jack – I found a summary link to the Forrester 2023 market prediction you mention, which is suggesting marketing automation growth of 14% CAGR from 2017 to 2023. dotDigital (LON:DOTD) have just had a 12% “organic” sales increase, in line with this. What I like about this level of annual market growth and recurring revenue is that a company like dotDigital (LON:DOTD) has to do nothing special to achieve a double digit annual sales increase. As a consequence of reading the market report summary, have just bought some more!

https://www.marketingdive.com/news/forrester-marketing-automation-spend-will-reach-25b-by-2023/522900/

I note also in today's £DOTG update that: Dotdigital was independently rated as a "Strong Performer" in the 2020 Forrester Wave Email Marketing Services Providers Report".

Proven quality in Software and IT: Moneysupermarket, FDM and Dotdigital

Moat or mirage? Refining the sample

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Jack Brumby

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