Why I Love These 5 Platform Companies

MarketsMotley Fool

If you build a software product once and serve multiple customers, that's powerful. If you put that product in the cloud and make it a scalable platform for hundreds or even millions of customers, it's even better. When your cloud-platform company is focused on a large addressable market and it benefits when its customers are successful, I get really interested. This article will cover five companies that meet all of these criteria.

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Shopify (NYSE: SHOP) and Square (NYSE: SQ) help entrepreneurs and businesses sell products online and in person. Mindbody (NASDAQ: MB) provides software that helps wellness service providers run their businesses. Q2 Holdings (NYSE: QTWO) helps regional and community banks provide web and mobile services for their customers. 2U (NASDAQ: TWOU) helps universities move their degree programs online.

Four of the five stocks have beaten the market over the last 12 months, and three of the five have more than doubled. Read on for traits that make these companies attractive stocks to add to your portfolio.

Scalable platform

These companies make money through a software platform that serves their customer base. Once the platform is built, these companies can meet increasing demand by adding computing power in the data centers that host their platforms. The business of hosting applications has become much easier and cheaper with computing costs declining and cloud-hosting companies cutting prices to win business.

These platforms are less capital-intensive and able to be more responsive to customers than companies that make products. With platform companies, enhancements or fixes can be rolled out easily via an electronic update without having to ship out any physical product.

Another advantage with a scalable platform is that it allows companies to focus on large market opportunities.

Growing in large addressable markets

For all of these companies, the size of the market compared to current revenue and growth rates should give investors comfort that these companies have a long runway ahead of them.

It's important to note that these addressable market figures are estimates of the total market opportunity as reported by the individual companies and likely don't represent how big the company could actually get. For example, the $1.9 trillion figure for 2U represents all spending related to higher education no matter how or where it's delivered. The only way 2U could get that large is if it became the only way for people to receive higher education, which is not very likely. What is important is that these companies are still small in comparison to the size of the market.

An additional characteristic of these platform companies is that a portion of the revenue comes from the success of their customers.

Alignment with customer success

All of these companies except 2U collect monthly subscription fees for access to their platform. These fees range in price based on the package, or number of features the customers have access to. But these platform companies are invested in their customers beyond just collecting a monthly fee. They are aligned with their customers' success and make more money when their customers make more money.

This idea of "shared success" makes these companies especially attractive to me as an investor. While it doesn't guarantee that these companies will make the right decisions all the time or even be successful, it does increase the odds.

And when paying customers come to the platform, it gives the company more capital to enhance or improve the platform. These enhancements make the platform more attractive, which will attract more customers. This is often called a flywheel effect, where platform improvements make the flywheel spin faster.

These companies are disrupting the markets they serve by providing a better product through a scalable platform. Their stocks are attractive because the companies are focused on large addressable markets and they experience success when their customers do. These five companies make up about 3.5% of my portfolio, but I plan to add to my positions. Maybe you should consider joining me.

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Brian Withers owns shares of 2U, Mindbody, Q2 Holdings, Shopify, and Square. The Motley Fool owns shares of and recommends Q2 Holdings and Shopify. The Motley Fool owns shares of Square. The Motley Fool recommends 2U and Mindbody. The Motley Fool has a disclosure policy.