Software companies often attract a very high valuation, at least at face value. Drilling down deeper into the economics of these business reveals the real value of owning a business with a sustainable ‘moat’ that can reinvest at high rates of return, says Kate Howitt, Portfolio Manager at Fidelity International.

Key points:

• Companies with a sustainable ‘moat’ that can reinvest in their business shouldn’t exist according to traditional economic thought
• When a company can grow their competitive advantage are compounding their value, which is known as a network effect
• The price-to-earnings ratio on these businesses look high, but these prices are justified by their ability to generate high returns on an expanding asset base
• Investors are beginning to understand the economics of these businesses, which has resulted in PE-expansion for some stocks
• As the market has come to realise this value, some of these stocks have become fully prices; this demonstrates the importance of an active approach.

For further insights from Kate Howitt and the Australian equities team at Fidelity, please click here