Investing in Long-Term Compounders: A Case Study of Roper Technologies Inc (ROP)

ROP is a highly diversified technology company operating a portfolio of 28 businesses, each operating (and leading) in its niche market.

Investors are constantly looking for ways to achieve respectable long-term returns. There are many methods they can employ, including value investing, growth investing, dividend investing, and others.

One of the most interesting investment methods that has slowly gained attention in the last decade is investing in long-term compounders. These companies operate highly profitable and low-capex businesses, which allows them to reinvest their excess profits back into the business over many years to generate sustainable long-term growth.

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Yet, finding one of these compounders is not that easy, so you must grab the opportunity when you can. Let's focus on a compounder that I have just added to my radar: Roper Technologies (NYSE:ROP).

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Diversified holdings of highly profitable businesses

Roper is a highly diversified technology company that operates a portfolio of 28 businesses, each of which is a leader in its niche market. These businesses belong to one of the three business segments, which are application software, network software, and technology-enabled products.

While it's obvious that Roper is a tech company, that wasn't the case in the early days. It was originally an industrial business that made home appliances, pumps, and other industrial products. The company has gradually shifted away from the highly capital-intensive and cyclical industrial businesses by divesting most of them over the last two decades. Now, it concentrates on owning profitable and asset-light technology and software companies with high margins and recurring revenue.

Specifically, its revenue is highly recurring, derived from software-as-a-service (SaaS), software maintenance, and annual licenses, which made up 57% of its 2023 revenue. A huge portion of the remaining revenue is from transaction-related fees and other professional-related fees, which are not completely recurring annually but would likely recur at some point over the years.

This focus on asset-light niche businesses offers several advantages. For example, Roper can grow its business with very few incremental capital requirements as it scales up its customer acquisitions for its SaaS business. Of course, it may incur some one-off customer acquisition costs.

As such, almost all of Roper's profits are available for reinvestment, which the company redeploys into its merger and acquisition activities. Furthermore, as it operates a highly diversified business model, Roper is more able to sustain its revenue and profitability even through difficult market conditions.

A proven and sustainable growth formula

If owning a diversified portfolio of niche businesses provides stability, then having the right capital allocation process helps Roper turbocharge its business model with sustainable long-term growth.

Roper's highly profitable business approach gives it ample capital to reinvest, which it has deployed patiently over the years to acquire even more niche and capital-light businesses. The tech company has a proven operating framework that it has followed over the years, allowing it to acquire the right businesses that would be value-accretive over the long run.

But the process doesn't stop there. After acquiring the companies, Roper helps them improve and scale their top line by leveraging its experience. These acquirees will also work on improving their margins and capital efficiency over time, again, with help and support from the parent. In short, these businesses get better over time as they fall under Roper's wing.

Beyond its acquisition activities, Roper has historically grown organically as its portfolio of businesses continues to serve and delight its customers in their respective niches. Together, these pillars help the tech company deliver respectable long-term growth. For instance, in the last 15 years (up to 2023), revenue and free cash flow compounded at 7% and 11%, respectively. And that's after divesting 40% of its revenue in 2018.

As such, Roper could sustain its growth machine in the coming years, if not decades, by leveraging its proven (and continuously improving) playbook.

What it means for investors

Roper is a rare example of what investors look for in a stock, combining excellent business economics and a proven growth formula that will sustain growth for years to come.

While it's probably too early to advocate an investment in the stock -- since investors need time to familiarize themselves with the company -- it makes sense to keep it on the watchlist.

Only when investors gain enough conviction should they make the next move.