Over the course of this week, I have been exploring why I think the Afterpay Touch Group Ltd (ASX: APT) share price is a buy in the first two installations of a three-part series. You can read my previous articles here and here.

Today, I finalise my series by digging a little further into…

Valuation

A company growing at the rate of Afterpay, with legitimate global potential is always going to be extremely hard to value. It will also receive valuations that tend to look absurd on traditional valuation metrics. Based on Afterpay's 2018 financial result of revenue of $142 million and the current market cap of $3 billion, it trades on a market cap/sales ratio of 21 times. Clearly, this would be absurd for many companies. But for a company with the growth potential of Afterpay, this could well be fair value, or even cheap.

How can you value a company that grew its revenue by 390% over the last year and is now entering into new markets that have greater growth potential? I believe that overthinking a short-term valuation for such a fast-growing company, with such a wide range of potential outcomes is futile. To value Afterpay, you must set aside traditional valuation metrics, try and look 5-10 years in advance, and think of how this company may be positioned.

If we look 10 years forward it is easy to see 'buy now, pay later' payment platforms built into nearly all retail online stores.

Before I explain my valuation process I will provide a brief disclaimer:

Beware, the remainder of this article involves a bit of number crunching, so don't worry if your head hurts after reading (mine did too). I am aware that this is a very rough valuation, and many things can change between now and the remainder of the companies global rollout.

The global ecommerce Business to Consumer (B2C) market has grown from $1.3 trillion in 2014, to $2.3 trillion dollars as of 2017 and is expected to grow to $4.5 trillion by 2021 according to Statista's ecommerce report. This is a compound annual growth rate of 19.4%.

This is a trend that does not look like slowing down either with ecommerce sales only making up 10.2% of overall retail sales in 2017 (statista.com). But due to the law of large numbers, you would expect it to slow down at some point. If we take a conservative CAGR of 10% going forward from 2021 out to 2028 we come to a total global B2C ecommerce market of $8.8 trillion dollars in 10 years from now.

China, the biggest ecommerce market in the world currently makes up 29% of the $2.3 trillion market with 2017 annual sales of $672 billion. Because China will probably be the largest contributor to the growing ecommerce market share out until 2028, let's assume they grow their market share to 35%. This is $3.08 trillion. China already has dominant payment platforms like Alipay embedded into their ecommerce market so I think it's unlikely Afterpay will target this market. The well-known government and regulation risks of international businesses operating in China is another reason why Afterpay will probably not go after this market.

So, if we subtract the $3.08 trillion of China's share of the ecommerce market in 2028 from the total addressable market we come to $5.72 trillion.

In the Afterpay business update published to market on September 19, they stated that they estimate that 10% of all physical online retail in Australia was processed through the Afterpay platform. This is a number I expect to continue to increase as they expand their service offering into other verticals such as travel, medical, and beauty which they have started implementing already.

To keep our estimates conservative, we will assume that in 10 years' time they achieve this same 10% of all online sales in the USA and UK.

Based on market share in 2017 the US had $340 billion (14.8%), and the UK had $99 billion (4.3%) of the $2.3 trillion ecommerce market in 2017. If we assume the US and UK maintain their market share proportion in 10 years' time they will offer market size's of $1.3 trillion and $378 billion respectively. The Australian ecommerce market is much smaller and was 10.8 billion in 2017 and is predicted to be 17 billion by 2022 and growing at 5.3% by 2022. By extrapolating 5% growth out until 2028 you get an Australian ecommerce market of 22.8 billion.

This is a combined addressable market for Afterpay of $1,300 billion (US) + $378 billion (UK) plus $22.8 billion (Aus) = $1.71 trillion.

If we assume 10% of these online sales transactions go through Afterpay's platform we get $170 billion of underlying sales processed per year.

A net transaction margin of 2.6%, which is what they achieved in FY18, equates to total revenue of $4.42 billion. Now that market cap of 3.7 billion does not look so silly after all.

If we use a P/S multiple of a similar business, digital payments system PayPal, which earned $13.1 billion in revenue in 2017 and currently trades on market capitalisation of $105 billion. This translates to a P/S multiple of 8. Apply a P/S ratio of 8 to the $4.42 billion predicted 2028 revenue of Afterpay, and you get a market cap of $35.4 billion. This is over 10 times the current valuation of Afterpay today and suggests Afterpay might be cheap.

There is no guarantee that Afterpay will trade on the same multiple as PayPal. I simply used PayPal to compare, as, on the surface, it looks to be a similar business. But even if it was to trade on a lower multiple in ten years' time, the estimated $4.42 billion of future revenue looks extremely cheap at today's price. I have also only included the three markets that they have so far signaled as targets, in Australia, USA, and the UK. It is also likely that Afterpay will enter other regions (already hinted in their investor presentation). Secondly, I have only assumed Afterpay processes 10% of online retail sales which could indeed be much larger as they progress into other verticals.

Foolish takeaway

There are no investment opportunities without risk and in the case of Afterpay, I suggest the future opportunities warrant a case for investment within a diversified equity portfolio.

The post Why I think Afterpay Touch share price is a buy: Part 3 appeared first on The Motley Fool Australia.

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Earlier this week I looked at some of the reasons I think the Afterpay Touch Group Ltd (ASX: APT) share price is a buy. Today, I continue to explore why in part two of a three-part series.

No obvious competitive advantage – but building one with time

As I mentioned in my previous article, I held out on investing in Afterpay shares for a long time due to being unable to identify a clear competitive advantage. I was not alone. I read many articles and blog pieces by fund managers and investors pointing out the mass of competitors in the 'buy now, pay later' space such as fellow ASX listed Zip Co Ltd (ASX: Z1P), and other international competitors, 'future pay', 'splitit' and 'dekopay' to name a few.

Eventually, I decided that whether I could articulate Afterpay's moat or not, was unimportant as it had become abundantly clear that Afterpay had been adopted by the most important group of people, their customers. From hearing my friends rave about how cool Afterpay was, to seeing their big signs pop up on every second store in the shopping centre, to the "Afterpay appreciation pages" on Facebook, where an online cult following would discuss their affection for the Afterpay service. The product was resonating with their customers, and all you had to do was look around to see it.

Anecdotal evidence was backed up by the numbers too. In the space of a few years, Afterpay went from an idea by a couple of entrepreneurs to an integral part of the retail landscape in Australia. In the latest market update, on November 28, Afterpay had >20 thousand retailers on board, >2.5 million active customers, and was processing >10% of all Australian online commerce through their platform.

The reason that Afterpay was able to gain such traction in a very competitive space is unclear. Clever marketing, great technology, and an accessible user interface are all potential reasons, but at the end of the day, identifying the reason may not be that important. What is important is, that it has achieved nationwide approval by its customers.

And now, as the company continues to expand its platform, a more obvious and tangible competitive advantage is beginning to appear. This is the same advantage that has served some of the world's most successful technology companies like Google, Facebook, and Amazon so well – a 'network effect' built through 'first-mover advantage'.

The network effect has been studied scrupulously by fund managers and analysts after identifying it as the propelling force behind the extreme growth of so many of the biggest technology companies in the world. It goes something like this (using Afterpay as an example) – Once you have a large contingent of customers on your platform (consumers), retailers need to join the platform in order to access these customers. In turn, the more retailers that adopt the platform the more attractive it becomes for the consumers. This becomes a reinforcing cycle, further embedding the companies competitive advantage.

Does winner take all?

The rapid adoption of Afterpay and similar products confirms that the interest-free 'buy now, pay later' space is one that is here to stay. An alternative to high-interest credit cards has been an area of the market ripe for disruption.

However, disruption does not necessarily correlate to investment returns. This is something the thousands of car manufacturers in the 1900s, or the internet-based companies from the tech-boom that went broke, can attest too.

In the case of Afterpay though, I suggest that disruption will lead to investment returns and will be a case of winner takes all. PayPal is an excellent example of this concept and is a good roadmap for the Afterpay platform. It makes sense when you think of it through the lens of the consumer. Nobody wants to have to use numerous different accounts each time you buy clothes or shoes online. It is a hassle and an unnecessary waste of time. Customers want one payment platform that they have to remember a username and password for, and that they are familiar using. Once a single payment platform has achieved mass market acceptance, then it becomes a liability for retailers to not offer the platform as a payment option. Customers will ask the retailer if they use Afterpay, and if the answer is no, they may be less likely to shop with them. Retailers are basically forced to adopt the Afterpay platform, or risk being left behind and losing customers to their competitors.

Australia conquered – but can they go global?

The rapid growth to 2.5 million active users in Australia has been impressive. However, for the investment thesis in Afterpay to be successful, with the current valuation of the company, it relies on global domination.

Early signs of the US rollout which began in May, have been promising. $115 million of underlying sales were processed through the Afterpay platform YTD (to end of October 2018), 300,000 consumers have transacted with Afterpay, and over 1,300 retailers have signed agreements to use the platform. These include brand names such as Steve Madden, Skechers, Urban Outfitters, and Kylie Jenner's brand, Kylie Cosmetics.

Another pleasing sign is that the recently announced expansion into the UK market was not driven by Afterpay management, but was requested by the company's existing multinational retail customers, who have operations in the UK. This clearly shows the value of Afterpay to the retail customer.

The decision to acquire ClearPay in order to help roll out the Afterpay platform faster into the UK makes sense also. If the 'buy now, pay later' market is a case of winner takes all, then Afterpay should continue to land grab as quickly as possible, expanding their network effect and further widening their moat. If an acquisitive strategy can speed up this process, then it makes sense to do so.

At this stage, it is unclear whether Afterpay will have the same success internationally as they've had in Australia, but the early signs are encouraging, and the strategy by management to invest heavily in growing their market position is the right one.

The post Why I think the Afterpay Touch share price is a buy: Part 2 appeared first on The Motley Fool Australia.

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Over the coming week, I'll be exploring, in a three-part series, why I think the Afterpay Touch Group Ltd (ASX: APT) share price is a buy.

Afterpay is currently one of the most polarising stocks on the ASX. On the one hand, you have the bulls calling it the next PayPal with global domination within sights. And on the other hand, you have the value investors, pointing out what they would call an absurd 3-billion-dollar market cap for a company that only produced approximately $100 million of revenue in its latest financial year result. That's an approximately 30x price-to-sales multiple. Ahem… yes, I said price-to-sales, not price-to-earnings. Let's just say this is not your typical value investor's stock.

I think both sides have their merits, but if I am to look at the potential returns on offer if Afterpay does go on to dominate the "buy now, pay later" space, versus the potential loss on investment if they don't, then to me, the upside far outweighs the down. It is this sort of asymmetric return profile that is very attractive.

This is not the type of investment for everyone though. Before making an investment in Afterpay, you should understand that there is a genuine risk that you could lose a large sum of your money if they cannot execute the global rollout of their platform. But does Afterpay deserve a low weighting in a well-diversified equity portfolio? I think yes.

I have followed this company for a long time and the one thing that held me back from an investment at an earlier point in time was the inability for me to comprehend, and articulate, their competitive advantage. I believed the concept was a great one, that provided great value to their customers, but I could not understand what was stopping competitors' coming in and offering the exact same thing.

One thing I have learned over my investment journey is that the market doesn't care about your personal belief about whether a company has a strong competitive advantage or not. If the product is resonating with customers on mass, then whether I personally believe in the product or not, is irrelevant. It can be hard to go against your own beliefs when investing, but if you are unable to put your own beliefs aside and recognise a product that has clear customer approval then you can miss out on some great investing opportunities.

A couple of examples of this for me was not originally investing in A2 Milk Company Ltd (ASX: A2M) or Blackmores Limited (ASX: BKL) because I personally didn't believe in their IP or claimed health benefits. This has prevented me from gains of 1200% and 600%, respectively. Whether I personally believed in the health benefits of only A2 proteins in milk products or not is irrelevant to how many cartons of milk, or tins of infant formula they sell. The real question is, do the majority of customers in their target market believe in the product? And in the case of A2 and Blackmores, their share price gains show that the answer is a profound yes.

Foolish takeaway

I have learned from these two examples that if there is clear momentum in demand for a company's product, which definitely has been the case for Afterpay, then I have to put my own beliefs aside, in order to assess the company as a potential investment.

The post Why I think the Afterpay Touch share price is a buy: Part 1 appeared first on The Motley Fool Australia.

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The other week, in my article, "4 Common Mistakes Millennials make Stock Market Investing"  I began to answer some of the questions I am frequently asked by my friends as a young investor.

My aim is to one-by-one, discuss these questions, and de-bunk  the misconceptions contained in them… 

The other week I answered the question, "Aren't shares really risky?". I discussed why I think this belief is a costly mistake. This week I will take a look at another common mistake made by investors. 

 Mistake 2 – "The market's crashing – I've gotta get out!" 

This is absolutely a real concern to have. But if you look at what a stock market crash fundamentally is, I think a lot of the fear factor disappears, which will help you to act rationally in times when many others cannot. Let's break down some important characteristics of the stock market for you to keep in mind as we discuss the repercussions of a market crash: 

• The stock market is essentially a market place for buyers and sellers to come together and buy a part ownership in real life businesses.  

• Stock prices over the long-run reflect the earnings of the underlying business. 

• Stock prices over the short-term can fluctuate heavily based on the sentiment and psychology of buyers and sellers in the market. However, over the long-run history tells us, that eventually share prices return to a level that reflects the underlying earnings of the business.  

Now keeping these characteristics in mind, lets take a look at what happens during a market crash. I will discuss the different types of market crash and in turn, how an investor can act during a crash to minimise loss of capital.

I believe you can separate the reasons of a market crash into two broad baskets, however usually it is a combination of both: 

• Economic downturn 

• Sentiment shift 

Economic downturn 

This is a situation where something has fundamentally gone wrong in the economy and has caused a large number of people to lose their jobs and therefore, their capacity to spend.

Examples of this are The Great Depression, and the 2008 Global Financial Crisis.

When less people have less money to spend then this is not a very rosy back drop for businesses to grow profits. As stock prices over the long-term follow the underlying trajectory of businesses' earnings, you can see how this would not be a good period of time for investing in stocks.  

However, the headwinds of investing during an economic downturn are not stock market specific. Property prices will also fall as buyers dry up and owners are forced to sell. Basically there is no easy-out for investors during times like this.  

Ways to reduce capital loss during these times are to focus on having exposure to "defensive" or "all-weather" stocks in your portfolio that are not affected as much by a consumer's reduction in wealth.

Examples of these type of companies are health care companies like CSL Limited (ASX: CSL) and Ramsay Health Care Limited Fully Paid Ord. Shrs (ASX: RHC), or a non-discretionary retailer like Woolworths Group Ltd (ASX: WOW). This is because people will feed themselves and look after their health as a priority.  

Fortunately, large economic downturns happen very rarely. They are also near impossible to predict. So if you choose not to invest because of the fear of an economic downturn, and you turn out to be wrong, you suffer a huge opportunity cost in all of the gains you have foregone by not being invested during this time.  

Sentiment shift 

This is a situation when investors have been feeling very optimistic about the returns on offer in the stock market so they continue to invest even as stock valuations become stretched.

Because stock prices can fluctuate around the intrinsic value of a business over the short-term, we can have periods of optimism where stock prices are bid up to extreme valuations. Sometimes this phenomenon is referred to as a 'bubble'. 

And as we all know, one day the bubble must pop. There will eventually be a change in sentiment that will bring stock prices back down to true value, or sometimes will they even overshoot in the opposite direction and sentiment will turn negative making stocks undervalued.  

This type of market crash is far more common, and is the time where good investors can make a lot of money and bad investors lose a lot.  

The reason people lose a lot of money during a crash is because they are psychologically affected by seeing a 'paper loss' in their portfolio. It is not a good feeling to log onto your brokerage account and to see red letters and numbers outlining how much money you have 'lost' in a day, a week, or a year. A poor investor will then panic, and sell all their stocks for low prices. 

Meanwhile, smart investors will make money during a downturn because they will be able to withstand their psychological pain, and identify quality businesses that are now on sale at discounted prices.  

One way to stay calm during times when you are psychologically feeling the pinch, is to come back to the three characteristics of the stock market that I have outlined. By remembering that prices can fluctuate over the short-term, but will ALWAYS return to a level that reflects the underlying earnings of a business in the long-term, you can sleep easy during turbulent times.   

Foolish takeaway

Market crashes are part of the parcel of investing. However, it is not a stock market specific phenomenon.

All investing markets go through ups and downs over the short-term. This includes property too. Property crashes are just not as psychologically damaging because you are not constantly being quoted with an updated price for your investment, like you are in the stock market.

So in the same way as you are unlikely to rush out to sell your house just because the price has dropped by 10%,  you should not do this with your shares either. By remembering that your investment in shares is a part-ownership of a real life business, and not just a ticker code, you will be more adept to withstand the psychological pain of a market crash and be able to reap the rewards over the long-run.  

The post Another common stock market mistake to avoid: "The market's crashing – I've gotta get out!" appeared first on The Motley Fool Australia.

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As a fairly young investor I am commonly asked by friends why I invest in the stock market.

By having these conversations, I have noticed how poor financial literacy rates are in young people in Australia. I am commonly asked questions like, "Aren't shares really risky?", "What if there is a stock market crash?", "Wouldn't my money be safer in the bank?", "Isn't buying shares just the same thing as gambling?". 

Over the following series of articles, I will one-by-one address these questions, and in the process hopefully there are a few millennials out there reading.

They can pass on their newly acquired knowledge to their buddies, and slowly but surely, we can boost our cohort's financial illiteracy.  

Question 1 – "Aren't shares really risky?" 

Well that depends how you define risk. Financial theory defines risk as the expected variance of returns over a given period. If we take shares as an asset class, and then apply this definition over multiple 1-year periods, and compare the variation with other asset classes such as real estate, bonds, and cash, then shares will probably come out as the riskiest of the group.  

But analysing an investment's performance over a 1-year period would not be a just assessment. When we invest in shares, we should really think of it as buying a business or a house. I mean that's literally what a share is, an ownership "share" in a company.

You would not usually invest a big chunk of money into a business or a house, to only sell it one year later would you? I mean maybe some people might, but that seems like a lot of effort to go to for not much reward.  

Instead, we usually invest in a business or house for the long-term. We buy the asset because we believe that in 5-10 years or longer, it will be worth considerably more than what we bought it for, and will provide us with a steady stream of cash along the way.  

The challenge is thinking about an investment in shares the same way. This can be hard to do with smartphones in our pockets, that give us 24/7 quotations of what our investment is selling for on the market.

Or with the 24-hour news cycle that we live in today that is constantly spreading sensationalist headlines like "the imminent stock market crash around the corner", or "$120 billion wiped off markets" in order to grab eye-balls.  

But if we can zoom out and look at shares with a long-term lens we see that a lot of the risk disappears.  

Sources: ABS, REIA, Global Financial Data, AMP Capital 

As you can see, although there are short-term periods of poor performance by shares, if you can stay calm during these times and ride it out, then you will be handsomely rewarded with an 11.5% p.a. return.  

Now if we look at the meaning of the word risk, then yes in financial theory it means variability of returns.

But what if you take a more literal meaning of the word risk, and look at the risk of not investing your money in an asset class other than cash?

A $100 investment in cash over 100 years (yes, this is an unrealistic timeframe I know, but it still illustrates the point) would have turned into approximately $10,000.

The same $100 investment over the same time period in either shares or real estate would have turned into $1.6 million. By taking the literal meaning of risk, clearly the choice to have your money sit in the bank, hoping you magically get rich is a hell of a lot more risky than investing in shares for the long-term.  

And that is if you were to do absolutely nothing but buy and hold. If you were really smart and could hold your nerve during one of the many periods of short-term underperformance, you could even buy more shares when they are "cheap" and boost your total return even more. 

For example imagine if you had been an intelligent investor who kept his head during the depth of the GFC and bought blue-chip companies like Commonwealth Bank of Australia (ASX: CBA), CSL Limited (ASX: CSL), and Ramsay Health Care Limited Fuly Paid Ord. Shrs (ASX: RHC) while they were selling at knock-down prices. 

Source: Commsec

As you can see in the chart above, you could have bought shares in CBA for $23.90 in the depth of the GFC compared to $60 a year ago. Buying shares when they are undervalued can significantly increase your returns on top of the 11.5% p.a. long-term returns already available in the share market. 

Foolish takeaway 

To answer the original question, no, I do not believe investing in shares is risky. This is a common and understandable misconception of people who do not understand the nature of financial markets. However, if you take the time to understand what ownership of shares actually means, and realise that it is a long-term investment, you soon see that the greater risk is the opportunity cost of having your money sitting in the bank doing nothing. 

The post 4 common mistakes millennials make stock market investing  appeared first on The Motley Fool Australia.

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August is a busy time of the year for stock market investors. This is because August 31 is the deadline for most publicly listed companies on the ASX to release their full-year financial results.

Due to this deadline, retail investors are bombarded with "market-sensitive announcements" through their brokerage platform, from companies that they are invested in.

This can be an exciting but also stressful period for investors. For example blue-chip favourites like Woodside Petroleum Limited (ASX: WPL), Insurance Australia Group Ltd (ASX: IAG) and Commonwealth Bank of Australia (ASX: CBA) reported recently.

While institutions have the luxury of employees who's full-time job is to pour through the pages of information issued by companies, retail investors, who may work a full-time job, do not have this luxury.

If you are a busy, time-constrained retail investor, then have no fear.

As we approach the second half of August, where the majority of companies will report, you can still stay on top of your investments. Below I've put together a quick checklist that in 15-20 mins that will cut through all the noise in the company reports and focus on what's really important:

1. Did they beat or miss management guidance/consensus earnings?

• Most retail investors won't have access to what is known in the industry as "consensus earnings estimates". This is when you pay for a service that combines the "sell-side" analyst coverage of companies, to produce an average earnings prediction for the upcoming result. If however, you do have access to a service like this, make sure you jot down the consensus earnings estimates for the companies in your portfolio before they report.
• Most retail investors won't have an expensive subscription to sell-side analyst coverage, and will have to rely on management guidance as a proxy for consensus earnings. In the lead up to your company's results, make sure you look back on previous market updates to get the latest management earnings guidance. Management usually give guidance on important metrics such as revenue, net profit after tax (NPAT), earnings per share (EPS), earnings before interest depreciation and amortisation (EBITDA) etc.
• Once the company you are interested in releases its report, compare the actual numbers to the ones management guided for or the consensus estimates. This will give you an instant read on the performance of the company. Usually an "earnings beat" is followed by an increasing share price and an "earnings miss" a falling share price. This is not an exact science though.

2. If they missed, why?

• Time to dive a bit deeper into the report. Look for explanations from management as to why they did not deliver on the guided numbers. Here you should be analysing management's justification and trying to put the company into one of two baskets:

1. It missed due to deteriorating structural/long-term conditions of the business or the industry it operates in.

· If this is the case it is usually best to sell your shares because the value of the firm is likely to continue to decrease with time.

2. It missed due to short-term factors that do not have a long-term effect on the value of the firm.

· Examples for this basket are contract-timing issues, one-off regulation or weather events, increased investment due to strong growth opportunities etc.

· This is the basket that can provide some excellent buying opportunities for the long-term focused investor. Many share prices will fall after a short-term earnings miss, as institutional money that has a short-term mandate, flows out of the company.

3. Forward outlook statements

• Sometimes a company will give some quantitative insight on how the first few months of trading in the new financial year have been going by releasing some key financial metrics. Other times it might be just a short qualitative description of trading conditions.
• If you have followed the company for a while you may have an idea on management's tendency to be either conservative or overly optimistic. Keep this in mind.
• Pay close attention to any outlook statements, the underlying tone, and management's track record of delivering on guidance. This may provide important hints on the future performance of the company and a good investment depends more on the future financial returns of the company than the past.

The post My essential checklist on how to interpret companies' profit reports appeared first on The Motley Fool Australia.

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Given the S&P/ASX200 index recently hit a new 10-year high of 6,248 points on June 21, it seems the domestic stock market is looking healthy.

But with the main contributors to the index, the big 4 banks, performing poorly so far in 2018, one begins to wonder where the index's recent outperformance has come from?  

Over the past year, the ASX200 has gained 7.9%. Meanwhile, big bank shares such as Commonwealth Bank of Australia (ASX: CBA), and National Australia Bank Ltd (ASX: NAB) have shed 14.3% and 16.7% from their 52-week highs respectively. 

With the big 4 banks making up approximately 24% of the index (according to BetaShares), it usually takes outperformance from the banks to significantly move our index higher.

In order for the index to move higher against this strong headwind others will need to contribute some seriously big gains.

The recent underperformance of the banks is most likely due to the Financial Services Royal Commission, as investors speculate on the effect of recommendations by Justice Hayne on future bank profits and dividends.

This has institutions and retail investors selling the banks and rotating their money into other stocks. 

One driving force for the index has been the resources sector. BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO), have gained 47.6%, and 35.2% respectively over the last year. 

I would argue an equally strong driving force has been the massive gains by lesser known medium-cap ASX tech stocks such as Altium Limited (ASX: ALU) (157.7%), Wisetech Global Ltd (ASX: WTC) (126%), Appen Limited (ASX: APX) (237%), REA Group Limited (ASX: REA) (33.2%), and Xero Limited (ASX: XRO) (84.4%).

Each of these fives stocks have smashed the market over the last year. They do not have as large weightings on the index as the big banks, but when the gains are this big, they will influence the index.  

"Great, let's just buy the Aussie tech stocks then" I hear you say, but unfortunately investing is not that simple. Investing returns are determined by the future performance of a business, but unfortunately looking in the rear-view mirror does not help us in this regard.  

Not only is the performance of the company important, but also the price you pay to buy the shares.

If the company performs well going forward, but that has already been factored into the share price at the time of purchase, then your returns will not be significant.  

Because of the stellar performance of the Aussie tech shares of late, valuations have potentially become over-stretched. If this is the case, future returns could be much lower, or even negative, as the market re-rates the companies to more realistic valuations.

Below I have included a table of some basic valuation ratios for the aforementioned companies, based off the most recent guidance provided by management.

These numbers scream expensive on nearly all of the traditional valuation metrics.

However, these are new age businesses with with extremely attractive economics. Businesses of this quality they deserve to trade at a premium. How big of a premium though, is the all-important question that can be difficult to answer.  

Personally, I think shares in Altium and Wisetech are too expensive to garner long-term outperformance. If I held these in my portfolio I would definitely look to reduce my exposure. 

That's not to say the share price of these companies will not increase in the near-term.

Momentum trading can do extraordinary things. Short-term trading is a high-risk way to play the stock market though, and you can easily be caught out and suffer massive capital losses.  

Over the long-term returns are determined by the price you pay and the performance of the business.  

I would say that REA Group and Appen are both holds at these levels, and the only company I would be comfortable buying at these prices is Xero.   

The post Are REA Group Limited (ASX:REA), Wisetech (ASX:WTC) & Appen (ASX:APX) overvalued?  appeared first on The Motley Fool Australia.

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Technology One Limited (ASX: TNE) is one of the leading global Enterprise Resource Planning (ERP) software providers to medium and large enterprises in Australia and around the world.

ERP software is basically used to integrate and simplify core business processes. For example, processes such as inventory ordering and tracking, payroll, HR, accounting, etc, are all managed on the one software solution provided by Technology One.

Technology One is the dominant player in this space in Australia and focuses primarily on the government and education sectors, where it boasts big name customers such as Melbourne University, Seven West Media Ltd (ASX: SWM), NIB Holdings Limited (ASX: NHF), and The Australian Department of Foreign Affairs and Trade, just to name a few.

It is also expanding into the UK where it manages approximately 45 customers, predominantly in the government and Higher Education sectors.

The company is regarded as the best Aussie tech stock by many financial commentators as management has consistently managed to grow earnings per share by a compound annual rate of 16.4% p.a. since 2008 (according to CommSec).

However, the share price has underperformed over a one-year time frame with the shares trading sideways in that time. The company has still been growing well in this time, but just not as fast as the market expected. I believe this has created a good opportunity to pick up shares in a high-quality company on the cheap.

Valuation

At the recent FY18 interim result Technology One management guided for 10%-15% profit growth for the full year. Taking the mid point of this guidance and multiplying by last year's earnings per share (EPS), will give them 15.9 cents of EPS.

Based on the current market price of Technology One shares, this puts the company on an FY18 PE of 27. I believe this is an attractive price to pay for a high quality company operating in the high growth sector of data and cloud computing.

This is much cheaper than fellow Aussie tech stocks, REA Group Limited (ASX: REA) and Altium Limited (ASX: ALU), that trade on PEs of 43 and 54 respectively.

Another thing to keep in mind is that at the recent FY18 interim report, management beat the profit forecast they had given to the market by 7%. So there is the possibility that the latest full year guidance of 10%-15% profit growth could also prove conservative and be beaten again, which would most likely see the share price re-rate.

Foolish takeaway 

Technology One has posted a lousy couple of years in terms of share price performance, however, this is a normal feature of quality companies listed on the stock market. Short-term underperformance can allow for attractive entry-points to the savvy investor.

The post Is Technology One Limited the most undervalued tech share on the ASX right now? appeared first on The Motley Fool Australia.

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What is Class Ltd (ASX: CL1)?

Class Ltd is the Australian market-leading cloud-based SMSF administrative software company. It provides accounting practices with a software solution to make their job less time consuming and more efficient.

The Class software allows accounting practices to spend less time on tedious manual processes, and more time on servicing their clients. The efficiency gains also allows them to grow their business at a faster rate. In fact, practices that use Class's solutions boast a 17% p.a growth rate. This is 3x the industry rate of 5.2% p.a. Clearly the product is adding value for its customers.

The company has benefitted from entering the sector at a crucial time, as software moves from the desktop to the cloud. This has has provided a 'first-mover' competitive advantage for Class Ltd, as it was the first provider to offer an entirely cloud-based solution. Because of this, they do not have the burden of having to maintain legacy desktop software, unlike the established providers who have been around for a long time.

By focusing on a purely cloud-based offering, Class Ltd is a nimble, capital light business, that is disrupting older SMSF software providers, and rapidly engulfing market share.

The business model reminds me of New Zealand tech stock, Xero Limited (ASX: XRO), which has been disrupting the SME accounting space over the past decade.

Are Class Ltd shares good value?

Class currently has a market share of 25% (FY18 half-year result), so there is a big growth runway ahead. Another growth lever for the company is the 'Class Portfolio' product, which has been gaining traction of late.

The product saw strong growth at the March quarterly update, with accounts up 30% on the previous quarter. This new product allows accountants to track and manage other investment portfolios outside of a client's SMSF.

Class shares are currently trading for around $2.45, well below its 52-week high of $3.65.

Shares were sold off after the company's latest Q3 update in March revealed slower-than-expected super account and total customer growth of 2.9% and 1.9% respectively. There are two reasons that could be causing the weaker Q3 numbers:

1. The migration of AMP accounts that had previously been using Class software, onto their own in-house software. This has been well flagged to the market by management at the last few reporting periods, but the exact date of commencement was unknown. It seems this commencement is now well underway, and with 8,800 SMSF accounts remaining, this headwind will continue to blow into the near-future.
2. A normal seasonal lull due to the rollover into a new calendar year. Something that stood out to me, when reading the Q3 update, was the consistent underperformance in Q3 of past years. This tells me this period of slower growth is only temporary.

All though these were slightly disappointing numbers, three months is hardly a suitable amount of time to draw any accurate conclusions. It may pay to note that Q2 was a very strong growth period with super account, and total customer growth of 5.2% and 7.2% respectively. This shows the company has still been growing strongly in recent times.

There have also been concerns about the company's increased marketing spend in order to attract customers, and what this says about competition in the sector. This is a valid question with the 2018 interim report showing the Customer Acquisition Cost (CAC) jumping to $125 from $112 in the prior corresponding period.

Although this may hurt profit margins in the short-term, I believe this is a smart strategy if it continues to translate into increasing accounts and customers on the Class platform, like we saw in Q2. Especially with the company's extremely high retention rate of 99.5%.

I will keep a keen eye on the next quarterly update to see if the company can bounce back to stronger growth in super accounts and customers. I will also keep an eye on retention rates, as a good measure of sector competition.

Until then, now could be a good time to buy while market sentiment is against the company. If the company matches its EPS growth from the first half of FY18 of 20%, then the company currently trades on a forward PE of 29 times. I think this is an attractive price for a fast growing, high-quality company, with sticky recurring revenues.

The post Is Class Ltd (ASX:CL1) a star growth stock at a fair price? appeared first on The Motley Fool Australia.

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