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A few weeks ago we analysed how local tech investors are increasingly saying “show me the money!”, as they seek signs of revenue and earnings traction.

Since then we’ve witnessed the biggest ever single day change in a stock’s value as Facebook warned that it faced continuing pressure on earnings margins due to the rising cost of security and privacy measures.

As we go into domestic reporting season, it’s worth comparing earnings margins for our tech companies — because it’s quite conceivable that investors will be asking: “show me the margin!”

Investors like high margins because they reflect the strength of a company’s underlying business model and in tech a key element of that is the pricing power delivered by the underlying intellectual property.

They also reflect how efficiently the company is running its cost structures.

Watch ASX tech expert Tim Knapton’s latest video:

The sub-sector that boasts the highest average earnings margin is software — led by MYOB (ASX:MYO) with an EBITDA earnings to revenue ratio of 44 per cent last year — which would be enviable in any sector of the market at large.

However, as with any other investment metric the margin has to be viewed in context.

MYOB’s margin is so high because it built a high share of a large addressable market pretty much from a single suite of accounting software.

But MYOB is now being caught fast by Xero (ASX:XRO) which is entirely cloud-based and cheaper.

Xero invests a much higher percentage of its revenues in R&D and that helps explain why it’s growing its top line so much faster.

Indeed, Xero only transitioned into a positive EBITDA last year but that will change as it enjoys economies of scale.

So investors will be keenly scrutinising what the changing competitive landscape means for MYOB’s margins.

Other software stocks with high margins are:

— Performance management software system provider Integrated Research (ASX:IRI)

— Online autoparts catalogue provider Infomedia (ASX:IFM)

— Cargo logistics platform operator Wisetech Global (ASX:WTC)

— Computer chip design software maker Altium (ASX:ALU)

Although most of the Australia’s clean techs are yet to transition into profitability, New Zealand boasts several clean energy players that have strong margins such as:

— Wind farm operator Tilt Renewables (AS:TLT)

— Hydro and geothermal power generator and retailer Mercury NZ (ASX:MCY)

Segment dominant digital media players like Trade Me (ASX:TME) and Carsales (ASX:CAR) also rank right up there.

At the other end of the spectrum, sub-sectors like Cloud and IT Services and engineering tech have relatively slender margins because their constituents lack truly differentiating technology and instead they compete mainly on service and reach.

That means the margin for operational error is low and is likely to be punished particularly severely.

 

Tim Knapton is the founder and CEO of online tech research and finance marketplace TechVoyage.   Its video/financial database and digital broadcast platform provide a more efficient way for investors to appraise listed and unlisted tech companies and for entrepreneurs to finance, acquire and exit them.   

Previously Tim was Head of Corporate Broking at Deutsche Australia and before that ran a research department for a leading broking house.  Tim has also been a freelance tech/finance journalist for more than 20 years and a columnist with The Australian Financial Review, The Bulletin, BRW, Shares and Australian Business.

 

This article does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.