Companies with wide moats are more likely to produce above-average returns. But superior technology is one of the least sustainable competitive advantages in the software industry.
Look for software companies that have maintained good economics throughout multiple business cycles. We prefer companies that have been around at least several years.
License revenue is one of the best indicators of current demand because it represents how much new software was sold at a given time. Watch for any license revenue trends.
Rising days sales outstanding (DSOs) may indicate a company has extended easier credit terms to customers to close deals. This steals revenues from future quarters and may lead to revenue shortfalls.
If deferred revenue growth slows or the deferred revenue balance begins to decline, it may signal that the company's business has started to slow down.
The pace of change makes it tough to predict what software companies will look like in the future. For this reason, it's best to look for a big discount to intrinsic value before buying.
Ref: The Five Rules for Successful Stock Investing by Pat Dorsey
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