The Nearmap Ltd (ASX: NEA) share price is up around 600% over the past two years over which I have regularly recommended it to readers as my top small-cap stock to buy.
One reason why I regularly tipped the company is its underlying economics that mean it could post fast-growing profits long into the future.
Lifetime Value of Portfolio
One simple metric I've flagged before that is important to understand with regard to the investment case is what the group calls the lifetime value (LTV) of its contracted subscribers.
It calculates the LTV by multiplying the annualized contract value (ACV) of its portfolio by its gross profit margin and dividing it by group churn percentage.
ACV is the forward looking sum of all subscriptions from paying subscribers over the 12 months ahead, while churn is the number of clients leaving divided by the total number of clients.
In other words if ACV and gross profit margins are rising while churn is falling three key operating metrics are moving in the right direction to produce a multiplier effect that delivers exponentially growing compound growth in LTV.
For example the group's LTV has grown from $480 million as at December 30 2018 to $1.07 billion as at December 30 2019 to what it revealed today as over $1.4 billion as at March 31 2019.
So we can see it's growing exponentially with $400 million of LTV growth over just its most recent quarter, compared to around $527 million for the six-month period to December 31 2019.
I'd caution that LTV is calculated using the multiplier of gross profit margin which makes it look more impressive as a headline number than it perhaps is, while it's far from certain to be delivered and on its own doesn't mean much if costs are also accelerating
On the other hand if the group's investment in technology keeps a lid on or reduces churn then LTV should keep growing like nuts assuming ACV growth.
For example if we do the maths backwards for the quarter ending March 2019 and assume the same churn rate as December 18 (6%) and same gross profit margin (82%) we can estimate that ACV has grown very strongly over the quarter ending March 2019.
For example $104 million in theoretical ACV multiplied by 82% and dividend by 6% churn equals $1.42 billion in LTV.
However, this would represent some gangbusters ACV growth over the quarter (from $78.3 million on Dec 31 2018) to mean it's more likely churn has reduced or gross profit margin is up. Either way ACV is the key growth metric for Nearmap investors to watch as the leading indicator of future profitability.
Overall though on my maths and estimates the company just posted a very strong March 2019 quarter and it's evident why the market has woken up to its profit-compounding potential in the years ahead. The stock printed a record high of $3.64 yesterday.
Other software-as-a-service businesses boasting similar economics to Nearmap, but totally different business models to consider include Xero Limited (ASX: XRO) and Pro Medicus Limited (ASX: PME).
