The global software and services industry has shown tremendous growth, even in the face of a global economic slowdown. The global software and services industry had total revenues of $ 2,482.8 billion in 2011, and a compounded annual growth rate (OTCPK:CAGR) of 6.3% from 2007 through 2011. The outlook for the software industry also seems quite attractive, with expected growth in sales to continue at over 6%, and with earnings expected to grow at a staggering 19.3% per annum over the next five years. From this industry I have picked three stocks: Microsoft Corporation (NASDAQ:MSFT), Oracle (NYSE:ORCL) and CA Technologies (NASDAQ:CA) for the analysis.
Analysis and Stock Valuation
Here are the numbers for the three companies for our analysis:
Rev Growth (3-year Avg)
EPS Growth (3-Year Avg)
Operating Margin %(NYSE:TTM)
Net Margin %
Expected Growth, %(per annum)
Dividend Yield, %
Dividend Growth %(3-year Avg)
Data from Morningstar and Financial Visualizations on March 19, 2013
Current Stock Valuation
Upside Potential (Premium) to Reach a Fair Stock Value
There are many ways to estimate the fair stock value of a company. For this purpose, we applied the discounted-earnings-plus-equity model developed by EFS Investment analysts to these competitors. The calculations based on this model allow us to suggest the following: currently, all stocks are well undervalued. In addition, EFS's fair stock price valuation indicates that CA Technologies is trading at the most attractive discount.
A giant in the industry, Microsoft Corporation, provides investors with stable revenues and a solid dividend record. Microsoft enjoys a dividend yield of 3.3% against an industry average of 1.7%, with a 4 year average growth in dividends of 12.4% per annum. The script is currently trading at a P/E of 15.4, down 41.7% from the industry average P/E of 26.4. Similarly, the stock also seems to be relatively undervalued on the basis of the P/B and P/S ratios of 3.2 and 3.3, respectively, compared to the industry averages of 3.6 and 3.8.
Microsoft is expected to maintain its historic growth trend of around 8% into the future. However, its growth is significantly lower than the industry average of 19.3%. The company is also operating at lower operating (26.9%) and net margins (21.2%) when compared to the industry averages of 36.6% and 28.3%. Similarly the ROE of the company is 7.8% lower than the industry average of around 30.4%.
Microsoft Corporation is a well diversified business, which has shown stable revenue and earnings growth in the past and is expected to replicate this performance in the future. With the current cheap valuation (based on multiples) and a high dividend yield, I give a Buy recommendation for the stock.
Oracle Corporation is one of the leading companies in the software world. A market leader in the in the relational database market, as well as the application server market segment, Oracle has recently faced immense competition from cloud computing technology, which is a direct threat to its business.
Oracle is currently trading at a P/E of 17.1, well below the market average, but it is trading at a premium in the industry when compared to the P/B or P/S multiple. The company has achieved a revenue growth rate of 16.9% over the last 3 years and an earnings growth rate of 21.6%, which is greater than the industry average. Oracle Corporation has also managed to run its operations efficiently, with operating and net margins of 38.3% and 28.4%, respectively, which are greater than the average industry margins of 36.6% and 28.3%.
However, the company was only able to achieve an ROE of 24.9%, which is 5.1% lower than the industry. This is not sufficient given the higher risk associated with the company, as indicated by a higher than average Debt/Equity Ratio. The company has also provided a dividend yield of 0.7%, which is lower than the industry average of 1.7%. The company's future prospects indicate a per annum growth in earnings of 11.9%, which is also significantly lower than the industry.
Given the low growth prospects, high risk and a lower dividend yield on the stock, I would give a Sell recommendation on the stock.
One of the leading companies in Cloud systems management, CA Technologies has seen slow but steady growth in the past. The company is expected to perform similarly in the future with limited growth opportunities and expected competition in the future. The future expected growth rate of 8% is far below the industry average of 19.3%. The company also has operating and net margins of 29.7% and 19.7%, respectively, which are well below the industry averages.
CA is a high dividend yield company with a yield of 3.9% compared to the industry average of 1.7%. The per annum growth in dividends over the past 3 years has been 58.1%. The company is also is trading at a significant discount from the rest of the industry based on comparables. The current P/E of CA is 12.7x , a discount of 51.9% from the industry average of 26.4x. Similarly, the P/B (2.1x) and P/S (2.5x) multiples are also lower than the industry averages of 3.6x and 3.8x respectively.
Given the low risk level of the company, a high and growing dividend stream and its cheap valuation, the company is a Buy recommendation.
What is the Most Profitable Bet?
Out of the companies discussed in the article, CA Technologies is the most promising bet. This company has the most spectacular dividend growth rate of 58.1% and the highest dividend yield of 3.9%. Microsoft's dividend grew at a rate of 12.4%, whereas Oracle's dividend grew at a rate of 29.4% over the last three years. CA is available at better valuation multiples in the market. The low price multiples, high dividend yield and tremendous dividend growth rate renders CA a great buy. CA is definitely a promising stock and will leave its investors with decent returns by the end of 2013.