Looking for intrinsic value
These are trying times for value investors. There’s nothing we enjoy more than finding a high quality business trading at a discount to its intrinsic value, but lately, they seem to be thin on the ground.
However, quality businesses are not in short supply. Take TechnologyOne as an example. It has a September year-end so hasn’t reported yet, but previous performance has made it one to watch. TechnologyOne has a number of appealing features, which include:
- It is an integrated enterprise software business which owns and controls all of its software products. It is not dependent on third parties to provide the solutions its clients need
- Adjusting for surplus cash on the balance sheet, TNE’s ROE is in the order of 70%. In other words it generates tremendous value on incremental investment in its business
- By providing an excellent customer experience, it achieves high customer retention rates – in the order of 99 per cent
- It spends 20 per cent of revenues each year on R&D – which it expenses. This means that current reported earnings are depressed in order to pursue strong growth in future reported earnings
On average, TNE has doubled in size every four years over the past 15 years. This is an impressive track record, and exactly the sort of outcome a long-term investor looks for.
The challenging part of course, is value. If TNE doubles in size over the next four years, and then doubles again over the following four, then the current price will look cheap. However, if it doubles in size over the next four years and then slows down, it will look expensive.
While we are confident in TNE’s future prospects, it is hard to be confident in these sorts of growth rates so far into the future. For now, TechnologyOne is another one to add to the wish list.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Kshitij Gupta
:
Tim, would it be possible to explain this – what does surplus cash have to do with value on incremental investment in its business ? I presume you are speaking about cash flow divided by capital? Can’t understand your point.
Thanks.
Tim Kelley
:
Kshitu,
ROE measures the return generated on the shareholders’ equity invested in the business. If the business has a lot of surplus cash in it (earning bank interest rates) it can be helpful to back out that cash (and interest) to see what return the underlying business assets are earning.
Mike Williams
:
Given valuations are stretched.at what point do you sell a quality company? REA and SEK spring to mind.
Roger Montgomery
:
REA seems very expensive to us it Seek appears to be trading at the upper end but within our valuation range. No interest in selling it. Could be a substantially bigger business in a decade from now
Paul Morris
:
Don’t understand Roger why you say that Seek is trading at the upper end of your valuation range when its 21 March share price of $17.39 is miles above consensus current year intrinsic value of $7.27 ?
Roger Montgomery
:
We aren’t Consensus Investment Management, we are Montgomery Investment Management. If you are referring to Skaffold you may like to roll your mouse over the SKaffold Value Line and you will see a range of estimates appear that corresponds to most bullish and most bearish estimates too. Our estimates are even more bullish than many estimates. Most importantly, if your time frame is long enough you will do very well owning Seek. The price you pay today however will influence your short and medium term returns more acutely.