The Best Companies of the Software Industry – August 2015

While ModernGraham supports the bottom-up approach to investing, many investors do utilize the top-down method, whereby an industry is selected before the company itself. With that in mind, this article will take a brief look at the best companies of the software industry, selecting the most promising investment opportunities within the industry, and giving a broad look into the industry as a whole.

Out of the more than 550 companies reviewed by ModernGraham, 17 were identified as being closely related to the retail industry. Of those, only three are suitable for the Defensive Investor, six are suitable for the Enterprising Investor, and the remaining eight are considered speculative at this time. Excluding any extreme outliers, the average company was rated as being priced at 97.79% to its MG Value (estimated intrinsic value), with an average PEmg ratio of 30.06. The industry as a whole, therefore would appear to be fairly valued, particularly in comparison to the market (see Mr. Market’s Mental State).

The Elite

The following companies have been rated as undervalued and suitable for either the Defensive Investor or the Enterprising Investor:

CA Inc. (CA)

CA Inc. is suitable for both the Defensive Investor and the Enterprising Investor. The Defensive Investor is only concerned by the low current ratio, and the Enterprising Investor is willing to overlook concerns regarding the level of debt relative to the current assets because the company satisfies the more conservative Defensive Investor. As a result, all value investors following the ModernGraham approach based on Benjamin Graham’s methods should feel very comfortable proceeding with further research and comparing the company to other opportunities.

From a valuation side of things, the company appears to be undervalued after growing its EPSmg (normalized earnings) from $1.33 in 2011 to $1.95 for 2015. This level of demonstrated growth outpaces the market’s implied estimate of 3.65% annual earnings growth over the next 7-10 years and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value well above the price. (See the full valuation)

Oracle Corporation (ORCL)

Oracle Corporation passes the initial requirements of the Enterprising Investor but not the more conservative Defensive Investor. The Defensive Investor is concerned with the lack of dividends, and the high PB ratio. The Enterprising Investor has no initial concerns. As a result, all Enterprising Investors should feel very comfortable proceeding to the next part of the analysis, which is a determination of the company’s intrinsic value.

When it comes to that valuation, it is critical to consider the company’s earnings history. In this case, it has grown its EPSmg (normalized earnings) from $1.29 in 2011 to $2.20 for 2015. This level of demonstrated growth outpaces the market’s implied estimate for annual earnings growth of 4.95% over the next 7-10 years.

In recent years, the company’s actual growth in EPSmg has averaged around 14% annually. The ModernGraham valuation model reduces the actual growth to a more conservative figure when making an estimate, but still returns an estimate of intrinsic value well above the current price, indicating that Oracle Corporation is undervalued at the present time. (See the full valuation on Guru Focus)

Yahoo! Inc. (YHOO)

Yahoo! Inc. qualifies for the more conservative Defensive Investor or the Enterprising Investor. Both investor types are only concerned by the lack of dividend payments. As a result, all value investors following the ModernGraham approach based on Benjamin Graham’s methods should feel comfortable proceeding with the analysis.

As for a valuation, the company appears to be undervalued after growing its EPSmg (normalized earnings) from $0.67 in 2011 to an estimated $2.92 for 2015. This level of demonstrated earnings growth outpaces the market’s implied estimate of 1.96% annual earnings growth over the next 7-10 years. As a result, the ModernGraham valuation model, based on Benjamin Graham’s formula, returns an estimate of intrinsic value above the price. (See the full valuation)

The Good

The following companies have been rated as fairly valued and suitable for either the Defensive Investor or the Enterprising Investor:

Ansys Inc. (ANSS)

Ansys Inc. qualifies for the Enterprising Investor but not the more conservative Defensive Investor. The Defensive Investor is concerned with the lack of dividend payments, and the high PEmg and PB ratios. The Enterprising Investor is only initially concerned with the lack of dividends. As a result, all Enterprising Investors following the ModernGraham approach based on Benjamin Graham’s methods should feel comfortable proceeding with further research into the company.

As for a valuation, the company appears to be overvalued after growing its EPSmg (normalized earnings) from $1.57 in 2011 to an estimated $2.67 for 2015. This level of demonstrated earnings growth does not support the market’s implied estimate of 13.72% annual earnings growth over the next 7-10 years. As a result, the ModernGraham valuation model, based on Benjamin Graham’s formula, returns an estimate of intrinsic value below the price. (See the full valuation)

Cisco Corporation (CSCO)

Cisco Systems Inc. qualifies for both the Defensive Investor and the Enterprising Investor. The Defensive Investor is only initially concerned with the short dividend record. The Enterprising Investor has no initial concerns. As a result, all value investors following the ModernGraham approach based on Benjamin Graham’s methods should feel comfortable proceeding with the evaluation.

As for a valuation, the company appears to be fairly valued after growing its EPSmg (normalized earnings) from $1.21 in 2011 to an estimated $1.66 for 2015. This level of demonstrated earnings growth supports the market’s implied estimate of 4.29% annual earnings growth over the next 7-10 years. As a result, the ModernGraham valuation model, based on Benjamin Graham’s formula, returns an estimate of intrinsic value within a margin of safety relative to the price. (See the full valuation)

Google Inc. (GOOG)

Google Inc. passes the initial requirements of the Enterprising Investor but not the more conservative Defensive Investor. The Defensive Investor is concerned with the lack of dividends and the high PEmg and PB ratios. The Enterprising Investor is only initially concerned with the lack of dividends. As a result, all Enterprising Investors should feel very comfortable proceeding to the next part of the analysis, which is a determination of the company’s intrinsic value.

When it comes to that valuation, it is critical to consider the company’s earnings history. In this case, it has grown its EPSmg (normalized earnings) from $11.85 in 2011 to an estimated $20.37 for 2015. This level of demonstrated growth supports the market’s implied estimate for annual earnings growth of 11.93% over the next 7-10 years.

In recent years, the company’s actual growth in EPSmg has averaged around 14.37% annually. The ModernGraham valuation model reduces the actual growth to an even more conservative figure when making an estimate, but still returns an estimate of intrinsic value within a margin of safety relative to the current price, indicating that Google Inc. is fairly valued at the present time. (See the full valuation on Guru Focus)

The Full List

To view the MG Value and PEmg information, you must be logged in as a premium member. Clicking on the company name will take you to the company’s latest valuation.

For the investor type, a “D” indicates the company is suitable for the Defensive Investor, an “E” indicates the company is suitable for the Enterprising Investor, and an “S” indicates the company is considered speculative at this time.

Disclaimer: The author did not hold a position in any company mentioned in this article at the time of publication and had no intention of changing that position within the next 72 hours. This article is not investment advice and all readers are encouraged to speak to a registered investment adviser prior to making any investing decisions. Please also read our full disclaimer.