Image source: The Motley Fool
In his 1996 letter to shareholders of Berkshire Hathaway, Warren Buffett gave the following advice to budding investors: “You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence.“
Sounds familiar
As an accountant, The Sage Group (LSE:SGE) is a company I know well. Over the years, I’ve used many of its products and lots of others do too. The group claims that over 6m customers use its financial, HR and payroll software.
The great thing about computer software is that you only have to make it once but can sell it multiple times. No matter how many copies you sell, the cost of production remains the same. This means it’s possible to earn huge margins.
During the year ended 30 September 2024 (FY24), Sage reported a gross margin of 92.8%, virtually the same as for the previous year. Also, because users like familiarity, they’re reluctant to change software suppliers. In FY24, the group reported that 97% of its revenue was recurring.
Over the years, Sage has significantly grown its customer base despite the emergence of many alternatives like Xero, QuickBooks and Zoho. And even though the US is its biggest market, it’s unlikely to be affected by President Trump’s tariffs.
But in common with many growth stocks, the dividend on offer is quite poor. Based on its FY24 payout, the yield’s currently (2 June) 1.7%.
Having said that, it’s equivalent to 54% of underlying basic earnings per share (EPS), which is a reasonably generous payout ratio for any company.
This apparent contradiction tells me that the stock’s price-to-earnings (P/E) ratio must be on the high side. Indeed, it trades on 32 times FY24 earnings. A high multiple is typical of a software compare but this isn’t far off the current average for the ‘Magnificent 7’. Yet I can’t see Sage growing like these titans.
Or can it?
Recent history
From 2019-2024, the average annual growth rate in earnings was 6.33%. However, this includes two years – 2020 and 2021 (we could call these ‘the Covid Years’) – when the group’s profit fell.
Exclude these, and the rate of expansion increases to 16.79%. That’s much more impressive. And it’s pretty much the same as analysts are expecting the Magnificent 7’s earnings to grow in 2025.
| Financial year (30 September) | Underlying earnings per share (pence) | Change (%) |
|---|---|---|
| 2024 | 37.9 | +22.6 |
| 2023 | 30.9 | +17.0 |
| 2022 | 26.4 | +10.9 |
| 2021 | 23.8 | -10.9 |
| 2020 | 26.7 | -4.3 |
| 2019 | 27.9 | -15.2 |
Although he acknowledges that very few companies will achieve this, the other piece of advice given in Warren Buffett’s 1996 letter was to only buy shares in companies “whose earnings are virtually certain to be materially higher five, ten and twenty years from now”.
The latest analysts’ forecasts are predicting Sage’s earnings to grow for at least the next three years. The consensus prediction for EPS is 42.8p (FY25), 48.8p (FY26) and 55.1p (FY27).
If these are achieved, the average annual growth rate from 2022-2027 would be 15%.
However, the group faces some challenges. Its customer base is predominantly small and medium-sized businesses. These are most vulnerable to an economic downturn. And with the move to cloud-based applications, it could be badly affected by a cyberattack.
Despite these possible risks, I think Sage is a company that long-term growth investors could consider adding to their portfolios.
