Technology ASX shares have a strong advantage compared to many other industries when it comes to growing profit.
There are plenty of high quality tech shares to think about like Altium Limited (ASX: ALU), WiseTech Global Ltd (ASX: WTC) and Xero Limited (ASX: XRO).
What Makes Tech Shares So Good?
When you think about some of the biggest businesses in their respective industries on the ASX, you can see they have useful economies of scale. Supermarket company Woolworths Group Ltd (ASX: WOW), car dealership company AP Eagers Ltd (ASX: APE) and retailing giant Wesfarmers Ltd (ASX: WES) are all examples.
But all of them face the fact that their products are tangible items that need raw materials, production, transportation to the distribution centre, distribution to the sales locations and storage (rent) until it’s sold.
Each additional unit sold still needs to go through that same process.
But with technology services it’s very different. The software requires development by some software engineers and then, these days, it’s hosted in the cloud which requires payment to a company like Microsoft or Google.
But in terms of selling the software to clients, the software is ‘infinitely replicable’. There are very few variable costs that go with selling those additional services. This leads to rising profit margins at the EBITDA (click here to learn what EBITDA means) and the net profit level.
When a company can grow its profit quicker than revenue it ultimately drives the share price higher because it’s the profit/earnings per share (EPS) which is one of the biggest contributors to share price changes.
Not all tech shares benefit from the economies of scale. Not all tech shares are profitable (or will ever be).
But if you can find the right ones that are profitable, have the impressive economies of scale with a good growth runway and a good balance sheet, then you could be on to a winner.
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Disclosure: Jaz owns Altium shares at the time of writing, but this could change at any time.