I think it makes a lot of sense to invest in ASX tech shares.
I'm not saying that just because technology is 'cool'. I think the businesses that predominately offer technology have inherent advantages that many other sectors simply don't have.
Commodity businesses have to hope that their customers will continue to need more product at a similar or higher price. Banks are heavily reliant on a good economy and they are (rightly) under heavy regulation. Insurers seem to get smashed every few years by a natural hazard event. And so on.
Cheap replication of software
ASX tech shares don't have a lot of major costs once the software is developed. Some businesses have very high gross profit margins. For example, Xero Limited (ASX: XRO) reported a gross profit margin of 85.2% in its FY20 result. When the gross profit margin is that high, it turns a lot of the revenue from new customers into profit at the earnings before interest, tax, deprecation (EBITDA) level.
Once an ASX tech share like Xero, Pushpay Holdings Ltd (ASX: PPH) or others have developed the software, it can be replicated very cheaply and rapidly. If Tesla wants to sell another car, it needs to manufacture it and ship it. A software business can just instantly distribute it over the internet. It makes it very easy to grow the business at a rapid rate.
A business like Pushpay – which offers tools for electronic donations for US churches – is very attractive. It can sell its product to any church in the US whilst utilising its existing software. A wonderful business like A2 Milk Company Ltd (ASX: A2M) has had to spend a lot of effort to build up its logistics network in the US. A2 Milk has to ship physical products to customers unlike many software businesses.
Pushpay was very successful at improving its profitability in FY20 with its gross profit margin rising by five percentage points from 60% to 65%. Pushpay is aiming to double its earnings before interest, tax, depreciation, amortisation and foreign currency (EBITDAF) in FY21.
Software as a service (SaaS)
Not only do the best ASX tech shares offer rapid growth and high profit margins, but they also have quite sticky revenue with their existing customer bases. Perhaps they could be called defensive ideas.
A client can't quickly switch from Xero. It would take a lot of time (and therefore money) to be trained up on a new system. Plus, if the ASX tech share's software is really good, then the client wouldn't even want to leave.
A business like Altium Limited (ASX: ALU) is another good example of this. Every year it materially builds its subscriber numbers and this helps grow Altium's revenue.
I like ASX tech shares that are able to offer a product that is regularly improved. Altium regularly updates its software. The SaaS model means that software companies can expect regular annual (or even monthly) cashflow from their clients which will continue for the foreseeable future.
ASX tech shares I'd buy today
There are plenty of ASX software businesses that look a bit bubbly to me. However, there are also others that look good value such as Pushpay and Citadel Group Ltd (ASX: CGL).
I also have my eye on names like Kogan.com Ltd (ASX: KGN), Redbubble Ltd (ASX: RBL) and even BetaShares NASDAQ 100 ETF (ASX: NDQ). However, whilst these names have done very well since the COVID-19 crash, it's hard to say if they're good value because it's difficult to know if the shift to online is somewhat temporary (in the shorter-term) or permanent.
