There are 58 software and services companies listed on the ASX. Three who rate particularly well on management quality and medium-term earnings potential are SMS Management & Technology (ASX: SMX), Integrated Research (ASX: IRI) and Technology One (ASX: TNE). Should you add them to your portfolio?
SMS Management & Technology
Major Activity: Services
SMS Management & Technology provides systems and technology integration solutions through offices in Australia, Hong Kong, Singapore and Vietnam. Its major customers are involved in financial services, digital data management, defence, health, utilities, infrastructure and mining. Although there is a degree of stability in having these organisations on its books, there are also potential risks as government policies change and the resource boom subsides. SMS recently announced it has acquired Indicium, further deepening involvement in cloud services.
SMS Management & Technology stacks up on indicative 2014 projections: P/E ratio of 9, return on equity of 32% and a grossed up yield of 8.5%. With good management and no debt, SMS Management & Technology appeals as a conservative investment with an attractive yield. Its medium-term growth prospects are reasonable.
Integrated Research
Major Activity: Software
Integrated Research focuses on developing performance monitoring diagnostics and reporting software. The major proprietary offering is Prognosis, a real-time performance software suite which is gaining industry acceptance worldwide. Existing customers include airlines, banks, stock exchanges and telecommunication companies. Approximately 20% of revenues are expended on research and development.
Here's how its indicative 2014 projections look: P/E ratio of 15, return on equity of 35% and a grossed up yield of 6.2%. One caution — protracted licensing talks with some major customers may impact 2013 earnings. With active management, no debt and proprietary software tied into strong growth segments (mobile communications, performance reporting, information technology) IRI is fairly compelling as a well founded medium growth story. Given the high exposure to international currencies, a weakening Australian dollar is an added bonus.
TechnologyOne
Major Activity: Software
TechnologyOne develops and supplies software for industries and organisations in the fields of financial services, health, education, community services, utilities and local government. Interestingly, TechnologyOne does not use resellers or outside support parties when implementing or servicing their customers. On average, 20% of annual revenues are spent on research and development. Listed in 1999, TechnologyOne claims to be Australia's largest enterprise software developer.
Here's a look at its indicative 2014 projections: P/E ratio of 17.8, return on equity of 41% and a grossed up yield of 5%. At current prices TechnologyOne looks fully valued – patience may pay off here and it is worthwhile adding this one to your watchlist.
Foolish takeaway
All 3 companies occupy their own niches in an ever developing industry. Over the past few years the information technology sector has been in a mild bear cycle as many major companies cut or delay IT capital spending. Slowly improving international economies and the pressing need to implement efficiency controls could be the catalysts to turn this bear.
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Motley Fool contributor Peter Andersen owns shares in Integrated Research.
