If the growth of software-as-a-service stocks over the past three years is any indication, Wall Street has finally caught on. Two of the biggest growers in this niche are e-commerce specialist Shopify (NYSE: SHOP) and customer-service-focused Zendesk (NYSE: ZEN).

Since the start of 2017, these two have returned an average of 460% for investors. That’s impressive. But which is the better buy today?

It’s obviously impossible to answer that question with certainty. But we can get a better idea of what we’re buying by comparing these companies on three different facets.

Financial fortitude

The first thing we’ll evaluate is each company’s financial fortitude. For this, we’re exploring one question: If a financial crisis hit tomorrow, how would it affect the long-term prospects of each company?

Companies with lots of cash on hand, for instance, can actually get stronger from such times. They drive competition out of the market, buy back their own shares at a discount, and even acquire smaller rivals.

Keeping in mind that Shopify is valued at roughly five times the size of Zendesk, here’s how they stack up.

Data source: Yahoo! Finance, SEC filings. Cash includes long- and short-term investments. Free cash flow presented on trailing-12-month basis.

It’s worth noting that Shopify’s balance sheet is probably even stronger. The company recently had a secondary offering that added more than $600 million in cash to the balance sheet, though exact numbers have yet to become available.

That said, these two are pretty much on even footing: They each have lots of cash and almost no debt and have just started becoming free cash flow positive. As such, I think they’re both very healthy. This one is a draw.

Winner = Tie

Valuation

Next we have a more difficult thing to measure: how expensive each stock is. There’s no single metric that can do the trick for us. Instead, we have to consider lots of different data points.

Data source: Yahoo! Finance, E*Trade. P/E presented with non-GAAP earnings.

I won’t mince words: Using the type of valuation that has been popular in the stock market over the past 50 years, both of these stocks are crazy expensive. Investors have obviously warmed to the SaaS business model, but that has driven valuation to stratospheric levels.

But in this exercise, we’re comparing two companies against each other, not against the market or history in general. Viewed through that lens, Zendesk is obviously the better choice, as it is cheaper on every available metric.

Winner = Zendesk

Sustainable competitive advantage

We’ve saved the most important variable for last: a company’s sustainable competitive advantage, or “moat.” Both of these companies have the same core moat: high switching costs.

When a merchant sets up a website, payment, shipping, and analytics tools on Shopify, why would they ever want to go through the hassle of changing to a different provider? And if you use Zendesk for everything from customer-interaction logs to chat to analyzing all the data you’ve collected, would you ever do anything to jeopardize all of that data?

The short answer is no — and that’s why both of these companies are not only able to retain most of their customers but get them to add more solutions over time.

Shopify, however, has additional moats that give it the edge. For one, the company’s app store benefits from growing network effects. Third-party app developers build tools for Shopify merchants that don’t cost Shopify a dime. But the company gets a portion of each sale. The more merchants that join, the more app developers are drawn to the platform.

Furthermore, Shopify is creating its own fulfillment network. The theory is that this network will challenge Amazon’s superiority and give merchants an agnostic choice (read: Shopify won’t steal business from its merchants like Amazon does). If Shopify is successful, it will also have a moat in terms of low-cost production (of fulfillment).

Winner = Shopify

And my winner is…

So there you have it: two expensive stocks with impressive balance sheets. Technically this is a tie. Whenever that’s the case, I give the nod to the company with the widest moat. In this case, that’s Shopify.

But I think both stocks are worthy of your attention. I own them both, and they account for 13% of my real-life investments. Ten years from now, you’ll be glad you considered — and invested in — both.

The post Better Buy: Shopify vs. Zendesk appeared first on The Motley Fool Canada.

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Mark Zuckerberg and Facebook (NASDAQ: FB) have changed all that. And the movement has spawned tons of rivals in its wake. Foremost among those is Twitter (NYSE: TWTR), which — thanks to constant communications from the White House — seems to be in the news every day. Both technology stocks are favored by growth-minded investors.

Between these two giants, which is the better buy today?

While we can’t know with 100% certainty, we can dig deeper for a better idea. Let’s compare these companies in three vital areas.

Financial fortitude

The only thing I want to know when looking at a company’s financial statements is this: Would it be hurt over the long run by a recession…or could it actually be helped by one?

How can a company be helped by a recession?

Those with lots of cash on hand, little debt, and strong cash flows can take advantage of others’ misfortune during a downturn. They can buy back their own stock at depressed prices, acquire agile start-ups, or simply lower their prices so much that the competition is driven out of business.

Keeping in mind that Facebook is valued at almost 17 times the size of Twitter, here’s how the two stack up.

Data source: Yahoo! Finance. Cash includes long- and short-term investment. Free cash flow presented on a trailing-12-month basis.

Both of these companies have strong financials. But if forced to choose, the scales are decidedly tipped in Facebook’s favor. Not only does the company not have any long-term debt to speak of, but even after increased spending on platform safety, it is raking in $18 billion in free cash flow.

Winner = Facebook

Valuation

Next we have to take a look at how cheap or expensive these stocks are, relative to each other. There’s no one metric to help us here. Instead, it’s best to consult a number of different data points to build out a more complete picture.

Data source: Yahoo! Finance, E*Trade. Non-GAAP earnings used for P/E when applicable. P/S = price to sales ratio. PEG = Price to earnings growth.

Here I would call it a tie. While Twitter’s price-to-earnings (P/E) ratio appears smaller, this has more to do with accounting practices than actual free cash flow (FCF). On the rest of the metrics, these two are close enough that I’m willing to say the differences are negligible.

Winner = Tie

Sustainable competitive advantages

The final comparison is the most important. A sustainable competitive advantage — or “moat” — is the most important thing for any investor to evaluate. In its simplest form, a moat is what protects a company from competition coming in and stealing away business.

These two companies have very similar business models. They both benefit from two primary moats: brand value and the network effect. As they collect more users, each company takes the data and the time users spend on the site and offers up ads for businesses to create sales.

A company’s brand is what draws users into its ecosystem. The more you hear about Facebook (or its subsidiaries: WhatsApp and Instagram) or Twitter, the more likely you are to join the service.

But when it comes to leading brands, there’s a clear winner. According to Forbes, Facebook owns the fifth most-valuable brand in the world, worth nearly $50 billion. Twitter, on the other hand, doesn’t crack the Top 100.

And then there’s the network effect. The way this works is that each additional user of a service makes the overall service that much more valuable. This makes sense: What’s the point of joining either social network if the people you want to connect with aren’t already on it?

Again, we have a clear winner. Facebook owns not one, but two of the most popular sites in Facebook and Instagram. Even though its users total 2.7 billion people globally, the company has still been able to increase its daily active users by 8%. Twitter — working off a much smaller base of 139 million — grew “monetizable daily active users” by 14%. Given the enormous size difference between their bases, Twitter’s growth would have to be much stronger to beat Facebook.

Winner = Facebook

And my winner is…

So there you have it: While both are relatively close in valuation, Facebook has a better financial position and a wider moat. If you had to pick one, I would go with Facebook.

That being said, I own shares of both companies. Combined, they represent roughly 8% of my real-life holdings. They are both worth considering. But when deciding how much to allocate to each, remember the results from above.

The post Better Buy: Facebook vs. Twitter appeared first on The Motley Fool Canada.

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That company is CrowdStrike (NASDAQ: CRWD). And while it has been growing sales at an impressive pace, that’s not the most exciting part. Instead, investors should really focus on CrowdStrike’s ability to utilize the network effect in a powerful — and underappreciated — way.

But first, let’s cover the basics

Before diving into this powerful network effect, let’s cover the basics of what CrowdStrike does. The company was co-founded by current CEO George Kurtz in 2011. Prior to that, he was the chief technology officer at McAfee. While there, he realized there had to be a better way to stop sophisticated attacks from bringing major corporations to their knees. He wanted his solution to be faster, more efficient, and — most importantly — cloud based.

CrowdStrike’s mission is simple: to protect its customers from breaches. With that in mind, Kurtz developed CrowdStrike to function with two major pieces.

• The Threat Graph — The cloud location where all of the data collected from all of CrowdStrike’s customers can be collected and analyzed. It is also where the magic of artificial intelligence (AI) and machine learning (ML) can go to work.
• Intelligent, Lightweight Agents — These are the tools that individual customers use to handle their company-specific cybersecurity concerns.

While it may be a crude analogy, think of the Threat Graph as an aircraft carrier. It’s where all of the important stuff is aggregated, but it doesn’t really do any of the combat itself. It’s a home base.

The Agents are like the individual fighter planes. They are the ones executing the plans, and they can use the Threat Graph as a resource when necessary.

CrowdStrike offers 10 different modules — or tools — for customers to choose from. Think of those modules as 10 different types of weapons the fighter plane can have on board. Those tools range from device control to vulnerability management to malware analysis.

Impressive results

We’ll get to the why behind CrowdStrike’s amazing growth in the next section. But first, let’s highlight just how popular the company’s solution has been.

Below is the amount of annual recurring revenue (ARR) CrowdStrike has had on its books at the end of each of the previous 11 quarters. In other words, if CrowdStrike has 10 customers each paying $1 million per year, that’s $10 million in ARR. When the company reports sales, it only reports $2.5 million — as all of that needs to be spread out among the four quarters. But the bottom line is that ARR gives a great view into the health of CrowdStrike and its popularity.

What’s more, this growth is presented on a quarter-by-quarter — not year-over-year — basis. Put it all together, and ARR is growing by 120% per year. The customers on the company roster include big names: 9 of the 20 largest banks and 44 Fortune 100 companies.

Increasingly, these customers are using more and more tools as well. Here’s the total number of clients using 4 or more (out of 10 currently offered) over a similar time frame.

Management also announced in the most recent earnings release that this figure just eclipsed 50%. When you consider that the base of customers has also been more than doubling every year, these gains are impressive.

For instance, if there were 100 customers total at the end of 2018, 30 of them were using four or more modules. If, by the end of 2019, there were 200 customers total, 94 were using four or more modules. We can’t just look at the percentages without also taking this into consideration.

What does all of this mean? As companies use more and more modules, CrowdStrike’s software becomes more embedded in their everyday functioning. As that happens, those customers are loathe to switch, introducing a powerful moat thanks to high switching costs.

A powerful network effect

Truth be told, those switching costs alone would be enough to get me to buy shares. But the additional network effect is what’s really impressive to me.

Put simply, a network effect exists when each additional user of a service makes the service more valuable. Facebook is the exemplar: What’s the point of going on the network if none of your friends are there?

CrowdStrike has realized an ingenious way of using this effect. Because of the power of the Threat Graph — and the AI and ML that make it stronger — each additional customer makes the tools stronger.

Here’s what I mean: If there’s a cyberattack that’s never been seen before taking place in Asia, and the victim company uses CrowdStrike, I don’t need to worry about the attack hitting my company. Why? Because the Threat Graph will analyze the attack, learn from it, and immediately send updates to the Lightweight Agents at each customer to protect against that attack.

Take those dynamics and multiply them out across more than 3,000 clients around the world. As you can see, it would be silly for a company not to choose CrowdStrike. The company’s first-mover advantage has allowed it to gain an imperative head start on anyone else hoping to mirror its business model.

Prepare for a bumpy ride

After all of this, it might seem silly to not put all of your money in this one stock. But despite my glowing recommendation — and the fact that I have skin in the game — I implore you to proceed with appropriate caution.

Because it invests so much in R&D and sales right now — as it should — the company has lost $45 million in free cash flow over the past six months alone! It is also valued at $15 billion — or more than 40 times trailing earnings. High expectations are definitely baked into the stock price, and any hiccups could send shares reeling.

That’s why my position currently accounts for just 2% of my portfolio. If you’re interested in CrowdStrike but want to protect yourself from larger potential losses, I suggest a similar allocation.

The post Here’s the Cybersecurity SaaS Stock I Just Bought appeared first on The Motley Fool Canada.

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