So far as part of the great industries for investment series, we've taken a look at two "green dot" industries that are generally attractive for investment, and three "red dot" industries that are probably best to stay away from:

"Red Dot" Industries

1. Airlines
2. Restaurants
3. Brick and Mortar Retail

"Green Dot" Industries

1. Payment Processing
2. Social Networks

Today, we add a third industry to the "green dot" list.

Over the last 30-40 years, this industry has produced some of the best long-term performers in the entire stock market, and yet today, there is more opportunity than ever. The industry we will look at today is enterprise software. More specifically, cloud-delivered enterprise software, known as "software-as-a-service", or SaaS.

This is, without a doubt, one of my favorite areas to go digging for stock ideas. Here are four reasons why.

The Addressable Market Is Enormous

Enterprise software is one of the largest industries in the world. According to Statista, global spending in enterprise software in 2017 was more than $352 billion dollars. That's up from about $225 billion in 2009, a strong 5.7% compound annual growth rate.

Those are already some attractive stats, but it appears that the industry is facing an inflection point. That same report predicts enterprise software spending to explode, growing to $425 billion over the next 2 years - a growth rate of 9.8%.

Why? Companies are relying on software more and more for critical business intelligence applications, systems monitoring, project management, supply chain optimization, and so on. Nearly every aspect of business is moving to "real-time" monitoring to keep up with competitive threats. These require investment in new types of software categories.

The need for ever expanding software solutions is not something that will slow down anytime soon, giving increasing competition and the need for efficiency to effectively compete. The size and growth of this market affords investors in it the opportunity to see some big gains, particularly from early-stage software vendors who manage to gain a solid foothold.

Another major catalyst for increased spend is the transition to "cloud" solutions. This brings us to the second point.

Massive Trend Towards Cloud-Delivered Solutions

The first wave of enterprise software was characterized by the "license and maintenance" model. An enterprise customer would spend time evaluating vendors, then pay a large license fee to license software, usually along with a recurring maintenance fee to receive patches, updates, and technical support. The software would be installed on the company's own servers, and usually kept within an internally-managed intranet.

This model has been in use for some time, and continues to be largely used even today. Some traditional examples include Oracle (ORCL) databases, Microsoft (MSFT) Office deployments, or HR systems like PeopleSoft.

However, there are a lot of problems with this model. For one, it involves a lot of extra expense for the customer. After purchasing the license, they then have to purchase computing and networking equipment to install the software, build out space to put that equipment (and secure it, and ensure proper environment for it, etc.), and hire an entire IT department to deploy and maintain it. That's a LOT of time and expense, for functions that are usually outside of the company's core competencies.

Another issue was the inability of the software to be accessed outside of the company's network. On-the-go access was very limited, if it existed at all.

The software-as-a-service model has turned these issues on their head. Instead of a "license and maintenance" model, cloud software deployments simplify it to a simple recurring subscription payment for ongoing use - no different than you pay your electric company. For this subscription fee, the cloud vendor hosts the software on their own servers and maintain it with their own staff, saving customers a lot of expense, expertise, and headaches. Software patches and upgrades are done automatically, in a non-disruptive way. Capacity increases are just a matter of paying a higher subscription fee. Employees can access the systems wherever they are through public Internet connections.

All around, it is a far better model of selling software. For the customer, it eliminates numerous expenses and headaches, allowing the company to focus on their core business. For the vendor, it provides a predictable, recurring stream of revenue as opposed to the old "big bang" revenue model, where adding new licenses was key and cash flows could be unpredictable.

There is little question that cloud computing is entering the explosive part of the growth curve. Latest forecasts from firms like Gartner estimate cloud computing to grow at over 18% annual rates through 2020, reaching over $160 billion dollars.

That looks like a pretty attractive place to be for investors. And, even should the cloud market achieve these lofty targets, that's still only about 1/3rd of the overall enterprise software market. The growth potential in this space is pretty enticing.

Highly Recurrent Revenue Model

There are few things more attractive in business than a regularly recurring revenue model.

Recurring revenue means predictable cash flow. If this doesn't sound exciting, it should. Predictable cash flow allows management to carefully chart its growth plans, planning spending and capital needs with high accuracy. When a business goes insolvent, it is generally because of cash flows unexpectedly disappearing, making a firm unable to meet its debt requirements. This is far less likely in a recurring revenue model.

Think about this... would you rather have regular income, or get paid double salary one year and half of your normal salary the next (and not knowing it would happen)? It's a no-brainer, right? Obviously being able to rely on regular income is what we want - it just makes life a lot easier to manage.

High Switching Costs For Customers

At last, we come to maybe the biggest advantage in the enterprise software space. We just talked about recurring revenues, but how do we know that half of customers won't just up and cancel their subscription one year?

The answer is easy - because they can't.

Look, its easy for most consumers to cancel their subscription services. Would life really be a lot different if you canceled your Netflix (NFLX) subscription? A lot of folks have decided they don't need to pay for cable TV anymore, "cutting the cord" with providers like Comcast (CMCSA). Switching from a subscription service like Spotify (SPOT) to something like Apple Music isn't all that disruptive to our lives.

But even then, it is extremely unlikely that any substantial percentage of subscribers decide to do this all at once. Aside from a major issue like a data breach or privacy incident, losing a large chunk of subscribers all at once just doesn't happen - even in a low switching cost environment. Even cord cutting - a very real consumer phenomenon - has only recently crossed the 3% subscriber loss barrier for cable providers, after many years of hype. That's a manageable loss.

In enterprise software, though, it's not so easy to just switch. Businesses manage their critical day-to-day functions on top of many of these systems: marketing departments with Salesforce (CRM), HR departments with Workday (WDAY), and software development teams around tools from Atlassian (TEAM). They have an incredible amount of time, training, and data into these systems. Switching would be incredibly disruptive.

Given this, enterprise software enjoy recurring revenues with very modest churn rates. For the most part - as long as they don't screw up - they can rely on the bulk of their customers to pay month after month, year after year. And in many cases, they can also rely on those same customers to buy more adjacent products to fit into their existing work flows.

Conclusion

With an enormous and growing end market, highly attractive recurring revenue model, and generally high switching costs for its customers, enterprise software is without question one of the most attractive industries to hunt for investments. A true "green dot" segment.