Thought Process: A Look At Two Stocks With Compelling Valuations

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I’m no professional stock analyst.

That’s a good thing because it means you can relate to what I’m thinking as I write about stocks.

Following last week’s stock analysis of CommVault Systems, Inc. (NASDAQ:CVLT), I realized that I could provide better information by providing more of an unfiltered narration as I go through stocks.

That also means you may read some random thoughts once a while.

Since I’m still going through the Forbes Best Small Companies list, I’ll continue providing more of an “over the shoulder” look at how I’m thinking as I try to go through this list.

I’m 25% through the list of 100 stocks and it’s only February. So far so good.

#25 Fortinet (FTNT)

When starting to look at a brand new company, I like to briefly browse the company website, get a feel for what they do and who their target audience is.

By understanding what market the company is targeting, you can make the qualitative analysis process easier. For example, a jeans retailer that targets teens is going to be extremely volatile in terms of business operations and cycles compared to a jeans company that only sells above $300 a pair.

You can see the difference in sustainability and competitive advantage simply based on who the target market is.

Now, Fortinet Inc (NASDAQ:FTNT) operates in a tough space of providing network security solutions focusing on products such as firewalls, spam filters and switches.


Products offered by Fortinet

This is an area I can understand so I can begin looking at the numbers before I decide whether I really want to dig in.

When it comes to fast growing tech companies, I’m always concerned about the potential of losing money simply because of my inability to foresee what’s going to happen a couple of years down the road.

I also prefer software and services tech companies over hardware based. Once equipment is purchased, it won’t be replaced for at least 5 years whereas in software, a yearly payment is required.

If you are user of Old School Value’s Premium Fundamental Analyzer, follow me and turn to the ratios section.

Here, you will get a good overview of the current status as well as a rough idea of whether a stock is cheap or expensive. The idea at this stage is not to get an accurate intrinsic value figure.

That’s for later if the stock is worth further consideration.


Fortinet Ratios | Click to enlarge

At the moment, the current valuation is high.

I don’t overly focus on relative valuations, but when I see a P/FCF of 56, EV/EBITDA of 32 with decreasing ROE, ROIC and CROIC, that’s enough for me to move on.

For fast growing small companies, I understand that FCF isn’t the best measuring stick because the company has reinvest into the business.

But when I come across a company where I’m uncomfortable performing any type of valuations, it’s a better use of my time to pass.

You can go a little deeper and check out margins, share dilution, how well management is being paid and the expected growth.

#26 Tyler Technologies

If you like the tech sector, you should really be going through the Forbes list yourself.

Since it’s looking for fast growth companies, a majority is made up of tech with high sales growth, ROE and margins.

On the flip side, when the market is raging, there is less opportunity because most of these companies have already raced upwards.

Tyler Technologies, Inc. (NYSE:TYL) provides software and services solutions to the public sector. Now this is the type of tech company I like.

I wrote about NIC Inc previously, where NIC Inc. (NASDAQ:EGOV) creates web based solutions for people to make payments via the internet for government services.

Tyler Technologies operates on the other end.

They create back end software and solutions to help local governments get things done.

My initial impression after reading the description was that growth would be limited. After all, the federal government isn’t going to increase spending on IT upgrades by 30% year after year for Tyler Technologies to take advantage of.

State and local government and primary and secondary education annual spending for applications and vertical-specific software is currently estimated at $15 billion, with a compound annual growth rate of approximately 2.9 percent forecast through 2015.

The above statement was listed on the company’s website under “highlights”. I can’t agree that it’s a highlight as it shows there is a cap to how big the company can get.

Moving on.

Tyler Technologies Numbers

Time for the ratios again.


Tyler Technologies Ratios and Notes | Click to Enlarge

My notes in the image above sums it up.

To get CROIC that is consistent like this, the company must have at least one of the following:

  1. management that understand the industry very well
  2. good asset allocation skills
  3. keen eye towards new investment opportunities

A lot of times, CROIC jumps around by huge leaps and crashes which doesn’t provide any comfort.

For a better view of CROIC, here’s a closer look.


Consistent CROIC is a great sign

Additionally, the balance sheet is clean, quality scores are good, and I love the margins.

The quality scores I’m referring to are located at the bottom of the ratios page.


Tyler Technologies Quality Score

If you are unsure about these quality scores, be sure to check out the following:

  • Piotroski score and spreadsheet
  • Altman z score components
  • Beneish score

Now the ratios show that it is clearly expensive, but I’m not passing on it yet.

Your criteria may be to move onto the next company if it’s above a certain metric like a P/FCF > 20.

However, I like this company and what it does.

Competition is very scattered and although major players like Oracle offer similar solutions, I doubt Oracle will be going after slow moving small schools and governments. A company like Oracle targets a completely different market which makes Tyler Technologies all the more attractive if comes down in price.

Again, I’m making this claim based on having a better understanding of the target market.

The numbers also back it up because Oracle’s total revenue last year was $37.2 billion.

Tyler Technologies is $416m which is just little over 1% of Oracle Corporation (NYSE:ORCL)’s revenues.

And without a huge fish bothering to eat up the market, Tyler Technologies has enjoyed it’s place in the industry.

That’s how you see a stock price chart like this.


Simple Valuations to Get a Better Understanding

Getting to valuation, FCF is consistent, profitable so a reverse DCF is a good idea to see what the expectation is.

Plugging in the TTM FCF value of $40m with a discount rate of 9%, the required growth rate is 34%.


Reverse DCF for TYL | Click to enlarge

Doing the same thing using the Graham Valuation, I get the following.


Reverse Graham Valuation | Click to enlarge

Here, an earnings growth of 42% is required.

I find that difficult to swallow.

With such high growth, any slight dip in earnings or growth is going to have serious negative impact on the stock.

I really do like the business but I don’t want to be on the wrong side of this one.

Tyler Technologies goes into my watchlist.

I’ll live to fight another day.

Download a Printable PDF Summary of Tyler Technologies

Click to download the PDF summary below.

If you are reading via email or RSS, you need to come to the site to be able to download the file.

Stock Analyzer Report TYL-OSV_Stock_Analyzer-0217



This post was first published at old school value.
You can read the original blog post here My Unfiltered Thought Process on 2 Stocks.

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