I want my portfolio to be full of shares with bright prospects and a competitive advantage over rivals. Those businesses are even more attractive when they're in an industry that is growing fast.
Class Ltd (ASX: CL1) is a self-managed superannuation fund (SMSF) software provider, which helps accountants process the SMSF accounts more efficiently. It only has a market capitalisation of $322 million, but this could grow strongly over the next few years.
Here are three reasons why I think it's a great business:
Aligned to the growth of self-managed superannuation funds
There aren't many shares on the ASX that you can point to as being very obvious beneficiaries from the growth of SMSFs or superannuation as a whole. Class is definitely one of those that does benefit, a vast majority of its revenue comes from SMSF processing, with each SMSF adding to revenue.
There is a growing number of SMSFs in Australia, the number of SMSFs grew to around 589,000 in December 2016. The accountants who use Class' service love it, meaning they will choose Class for any new work they win.
Cloud accounting is the future of the industry
More and more accountants are acknowledging that cloud accounting is the future of the industry with Xero FPO NZX (ASX: XRO) and Class both finding a lot of success by taking a cloud-only approach.
Class had a 21.7% market share of all SMSFs at 30 December 2016, with a market-leading position of SMSFs on the cloud. Therefore the more that SMSFs transition from desktop accounting to the cloud, the bigger market share Class will win.
Being the first mover onto the cloud means Class has had more time developing its systems and is seen as the industry leader. Accountants are voting with their continuing subscriptions, with Class' retention rate of clients over 99% (excluding AMP Limited's (ASX:AMP) move). Only a fantastic service and business can hold on to customers with that level of retention.
Any competitors would have to offer a much superior product to tempt people to leave Class, bearing in mind the amount of time and training it would take to move to a new system.
Results
Class is producing wonderful results in a variety of different measures. In its December 2016 update, Class updated the market to say that it increased its number of portfolios by 5,745 to 130,216, which was a 4.6% increase in three months.
It's been achieving that strong level of customer growth for a number of quarters, which is why in FY16 it grew revenue by 45%, underlying net profit after tax by 71% and the dividend by 67%.
Class could have another few years of strong growth like FY16, as more SMSFs transition onto cloud accounting, Class has a great chance to become the dominant player if it keeps growing at the rate it is.
Risks
The two main risks I can see with Class are competitors and its valuation because it's trading at a high multiple. At the moment there is no serious cloud competitor to Class, though BGL is transitioning its clients to a cloud based system. In time, BGL may offer a more competitive product, so Class will have to make sure it keeps one step ahead with good development.
Time to buy?
It's hard to know what is an appropriate price to pay for such a fast growing business. It's trading at 51x FY16's underlying earnings per share (excluding IPO expenses) with a dividend yield of 1.49% (which is expected to be fully franked from the next payment onwards).
Its shares have declined by 36% since September 2016's all time highs. At today's price, I think it would be a great long term hold for any Fool. It could turn into a big dividend payer in time if it keeps growing the dividend by double digits each year. If you own a SMSF, or are thinking of making a SMSF, then you should read this report.
