Last month I wrote an article on lessons for investors from the best performing ASX listed share over the past decade. Pro Medicus (ASX: PME) has delivered eyepopping returns of over 60% annually over the last 10 years.

I attributed the strong performance of Pro Medicus to several factors:

  1. Potential for revenue growth: The opportunity for high revenue growth.
  2. Scalability: The ability to scale as revenue expands so earnings grow faster than sales.
  3. Sustainable competitive advantage: The ability to hold competitors at bay as market share increases.
  4. Reasonable valuation: A company that is relatively overlooked so valuation levels increase as more investors raise their expectations for the future.
  5. The potential for everything to go right: A company with a wide range of potential outcomes so if everything goes right the company will exceed expectations.

I screened our coverage universe in Australia to find a candidate that might be able to deliver exceptional returns over the next decade.

To double an investment a share needs to earn an annual return of 7.2% a year over a decade. That is decent but is less than the annual returns markets have typically delivered over the long-term. The purpose of this exercise is to find a share that becomes a multi-bagger. We are looking for a share that could potentially deliver more than 14.4% annually over a decade. This is no small feat.

The share I am going to run through this exercise is WiseTech (ASX: WTC). Does this mean WiseTech is going to be a multi-bagger over the next decade? Of course not. More than anything this is an exercise to explore what it takes to deliver exceptional returns. This is also a demonstration of how hard it is to find a share that can do that.

WiseTech Global (ASX: WTC)

WiseTech is a technology company that provides logistics software. WiseTech’s core product suite, CargoWise, provides the best-in-class software solution for international freight-forwarding.

Potential for revenue growth

WiseTech provides software for logistics companies that currently rely on in-house developed software and manually processes. This provides an opportunity for revenue growth if they can continue to win new customers.

Morningstar Equity Analyst Roy Van Keulen estimates that revenue will grow at a compounded annual growth rate (“CAGR”) of 21% over the next decade. That is a good start.

Scalability

Software is naturally scalable as the costs of developing software can be spread over larger customer bases with little incremental cost. The question comes down to how much it costs to sell and onboard new customers.

Van Keulen forecasts earnings before interest and taxes (“EBIT”) margins to rise to 51% by fiscal 2033 from 37% in fiscal 2023 due to CargoWise’s network effects reducing customer acquisition costs.

As a product-led company, this means that Van Keulen’s expectation is that both WiseTech’s sales and marketing, and research and development spending will come down as a percentage of revenue. This is another positive sign. Revenue growth is expected to be 21% per year for a decade and margins are forecast to increase so WiseTech keeps more of each dollar of sales.

Sustainable competitive advantage

Fast growing companies become targets from both existing competitors and new entrants into the market. Van Keulen ascribes WiseTech a narrow moat based on switching costs and network effects in its core CargoWise product suite. He expects WiseTech’s competitive advantages to be durable over at least the next decade.

CargoWise’s switching costs are evidenced by its industry-leading customer retention rates of over 99% per year during the past decade, despite the company implementing material prices increases for many customers in recent years. This is an exceptionally high retention percentage and means that new sales will add to revenue instead of constantly churning through customers.

CargoWise has many potential touchpoints across a customer’s operations which means that implementation of supply chain execution software is inherently highly complex. As a result, implementation of the software requires multiyear rollout projects as processes are mapped, technologies integrated, and people trained. Given the high upfront capital expenditure and the mission-critical nature of the product, once implemented, CargoWise customers have been reluctant to switch providers.

Van Keulen also sees evidence for network effects in the CargoWise product suite. Freight-forwarders select and co-ordinate the operators of physical assets, such as ships, airplanes, trains, trucks, and warehouses, to move goods. Using CargoWise results in significant labor cost savings for freight-forwarders.

Given the cost-focused nature of the logistics industry, we believe this incentivizes freight-forwarders, which operate as gatekeepers in the supply chain, to prefer operators that are integrated with the CargoWise platform. Hence, asset operators are incentivized to integrate with CargoWise to win business. This in turn increases the pool of potential asset operators that freight-forwarders can work with in a highly efficient manner, thus creating a network effect.

Reasonable valuation

Returns on shares come from dividends, changes in valuation levels and earnings growth. If a company is able to grow earnings quickly while increasing valuation levels this can turbo-charge returns.

This doesn’t happen often. Higher growth companies tend to trade at higher valuation levels. This makes sense. But it also limits the ability for valuation levels to increase in the future. This tends to only happen if the company is overlooked by investors or if high growth rates increase above the already high expectations of investors.

Van Keulen’s fair value estimate is currently $100 and the shares screen as fairly valued. The price to earnings ratio is currently 148 which is not only high but also higher than the 5-year average of 90. More on this red flag later.

There isn’t much help from the dividend. The shares currently yield 0.16% so returns are going to have to come from increased earnings and changes in valuation.

The potential for everything to go right

The range of potential outcomes varies across different companies. Large companies with established products have more predictable outcomes. Less established companies that do not have established products could hit it big or could fail to gain traction.

Valuation levels are based on investor expectations for the future. For any company the key to increases in share prices are exceeding expectations. For companies with wider ranges of outcomes there is more of a chance to exceed those expectations meaningfully – and more of risk of not meeting them.

WiseTech receives a high uncertainty rating from Van Keulen which denotes a wide range of potential outcomes.

The logistics industry is still in the early stages of digitizing, which means there is still high uncertainty regarding the ultimate market opportunity for WiseTech’s current and future products, as well as the adoption rate of WiseTech’s offering within the market. Although Van Keulen sees the market opportunity as large and highly winnable, WiseTech needs to create the products to seize on this opportunity.

If adoption is more widespread than estimated the share price could go up significantly. If adoption is lower than expected than look out below.

One of the keys to have everything go right is good decisions by management. Van Keulen has high praise for management. He describes investment efficiency as “exceptional”. He also credits WiseTech for its disciplined approach to operating expenses, especially during the pandemic, when WiseTech experienced rapid growth as its customers brought forward digitization initiatives. However, rather uniquely among technology companies, WiseTech did not grow its expenses in line with this abnormally strong revenue growth. Recent increases in hiring and acquired provide further evidence of counter-cyclical spending.

Great management is a positive but also introduces a risk. Van Keulen has called out key person risk. WiseTech has been managed exceptionally well by its founder and CEO Richard White, who still owns around a third of the company. White enjoys a stellar reputation in the industry and Van Keulen has the impression that he has been instrumental in developing and executing the WiseTech vision of becoming the operating system for the logistics industry.

For example, under White’s leadership CargoWise transitioned toward a usage-based pricing model at least a decade before the broader technology sector embraced the benefits of this customer-aligned business model. Van Keulen sees many examples of iconoclastic behavior which would make White especially difficult to replace, such as his directive leadership style, a focus on profitability and his mantra of “slower today, faster forever,” all of which stands in stark contrast to the broader technology sector of decentralized innovation, growth at all costs and mantras like “move fast and break things.”

What needs to go right

Given the valuation levels I believe that growth will have to meaningfully exceed Van Keulen’s estimates to earn the type of eye-popping returns we saw from Pro Medicus. Is this possible? It is. It is all about accelerating adoption.

The interplay between valuation levels and earnings growth is critical here. I am sceptical that in a decade the price to earnings ratio for WiseTech will be hgher than today and expect it to contract. Earnings growth will have to outpace the decline in the valuation level significantly to deliver eye-popping returns.

We can use an example to illustrate this dynamic between earnings growth and valuation levels. In the last 12 months WiseTech earned $0.67 a share. If the earnings were to grow 30% a year over a decade from revenue growth and improving margins the earnings per share would be $8.96. If the price to earnings ratio was cut in half from 148 to 74 the shares would trade at $663. That would equate to returns of over 21% a year.

Before popping the champagne, I need to point out that a price to earnings ratio of 74 is still extremely high. And 30% earnings growth over a decade is very hard to accomplish. Nobody said this was going to be easy.

The shares are up just over 30% year to date. Would I feel better about purchasing the shares earlier in the year when WiseTech was on our Global Equity Best Ideas list? Absolutely. But I think the potential is still there for outsized gains. An investor just needs a lot to go right.

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