Today we will be taking a look at Software as a service stocks. And if you have never heard of this concept before, it might be a good business model to familiarize yourself with because this is a segment of the market that is experiencing huge growth right now. In fact, if we look at my M1 finance portfolio, which is my main investment portfolio, you can see that I have 25% of my money going into these software as a service companies right now. And if we look inside of this software as a services pie we can see that I have nearly 20 stocks in here. These include stocks such as Adobe, paycom, zoom, okta, and fastly. And if you have watched any of my other videos, you would know that Shopify, which technically is considered a SaaS company, makes up a big percentage of my investments.

So this video will be organized into three parts. The first part will be a history of software companies and why the software as a service business model is great for not only companies but also end users. Second, we will look at how to quickly analyze these stocks to see which ones have the highest potential. And third, I will give you my top 5 picks for stocks in this space. So if you are new to the concept of SaaS companies I would recommend watching the entire video but if you instead came just for the picks then you can skip to the end.

For SaaS stocks above 50 billion market cap, there are only 9 stocks to choose from. Based on the stock returns over the last five years, adobe has the highest return with a 39.77% annualized return which is very good. Next you have autodesk, followed by microsoft, zoom, intuit, and salesforce. Based on the five year returns of these stocks, it looks like any of these six stocks would be a good investment but the top four are all above 30% annualized returns while intuit and salesforce are sitting right around 20% returns. Something else that stands out to me is that microsoft looks to be the best risk vs return ratio here. It is a 1.6 trillion market cap stock that has been able to grow by 33% a year for the past 5 years. Which is very impressive for a stock it’s size.

For SaaS stocks in the 10 billion to 50 billion dollar market cap range, there are 27 stocks. And if we sort them by the highest 5 year annualized return, the top stocks in this section have much higher returns than the stocks we just talked about. But what is interesting is that only 10 out of the 27 had higher returns than Microsoft did over the past five years. So holding a smaller company is no guarantee that it will outperform a larger company’s stock such as Microsoft. I would personally recommend buying all of the top 8 in this section but if I had to choose five I would probably go with Veeva and paycom as my top two, followed by Okta, twilio, and team. I like veeva and paycom the most because they are actually profitable. Which is a really good sign in my opinion. And keep in mind these SaaS companies don’t need to be profitable to satisfy the rule of 40 because a lot of these companies have very high revenue growth. But at some point, they will need to become profitable to have a sustainable business. Now I also own Coupa software and Ringcentral in my portfolio because they are such high performers. But I like stocks like paycom, Veeva, and okta because I like their business models a lot and they each service different sectors of the market. There’s a lot more I could get into here, but this is more of a high level overview so I am keeping it vague on purpose.

The next section of SaaS stocks are those with market caps under 10 billion dollars. These are the SaaS stocks that will be the most risky. And in my opinion, I think it’s best to stay out of this market cap range. There are 91 stocks in this section and it’s very difficult to pick the winners. The software as a services segment of the market is very competitive and it has a fairly low barrier to entry. So what this means is that a lot of very small SaaS companies will fail. Also the returns on these stocks are not that great. In fact, only 5 stocks in this category have higher 5 year returns than Microsoft. So in terms of risk vs return ratios, you can see how good of an investment Microsoft has been over the last five years. Now despite the risky nature of these stocks, I do own one of these stocks in my portfolio and that is alteryx. And as you can see alteryx has performed very well over the past five years. But I will say this about alteryx, they had disappointing earnings which caused the stock to drop 40%.