Lock In A 30% Upside With LifeLock

| About: LifeLock, Inc. (LOCK)


LifeLock has strong growth with an annualized growth rate of about 30%.

The company has fallen in value to a more fair valuation of about 34x EPS.

FTC action has caused LifeLock to fall in value, but upside remains strong.

Sometimes, I end up buying equities on more pure technical analysis to justify a strategy, and then after learning more about the company, I find that the fundamentals can show a whole new world. A few months ago, this happened to me with LifeLock (NYSE:LOCK). I bought it when it was trading at $11.60 a share for a covered call strategy and now it's moved close to $3.00 up from that price. My analysis shows that LifeLock is a great growth company and has a future that can most definitely support its current price -- it may even add more in the next several years.

Technically Speaking

When I use a covered call play, the bread and butter of this strategy was volatility. The entire idea is based off the theory that a covered call seizes on volatility in neutral, bull, or bear scenarios. Therefore, we look top down when analyzing an equity. In the case for LOCK, the volatility at my entry point was 43% and past performance showed that it was going up.

Next, price movement indicated that the equity had already hit its bottom and was on the rise. This was verifiable using a trend indicator, like ADX, which fell into the twenties from the high forties. Anytime an equity is trading 20+% below its 52 week high, there's usually a fundamental reason for concern. However, upon further research, the trigger for the drop was an FTC investigation over false advertising. Based on recent movement and lack of indication otherwise, regulatory action should be settled with the removal of the offending Wallet app. I will address the importance of Wallet in the growth section. Finally, with a market cap of $1 billion, the company has its feet in the water, so elevated volatility is less reason for worry and more reason to consider the investment opportunity.

The Fundamental Case

For true investors, a technical case is near meaningless unless the claims presented in technical analysis can be explained and justified with fundamentals. I currently feel that a technical case simply does not do justice to the long position in LifeLock, since the indicators mostly show only how this company is a "fallen angel" in terms of price. The company has only recently (in the past two years) turned the corner to positive income. This shows that LifeLock can quickly go from a company which shows promise, to a powerhouse within a few years.

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LifeLock is doing a great job at expanding its core business while adding close to $100 million in new revenue in 2013, resulting in a whopping 30% growth rate. If management can keep this up, they will have revenue in the billion range within 5 years. To be fully financially stable though, management will have to find a way to more effectively grow revenue without adding too much in the way of additional expenses.

In the past, the company has been accused of being overvalued, with a price that traded 50x EPS. As the chart below shows, LifeLock has fallen considerably in P/E to a much more reasonable valuation at 35x EPS. Although the chart shows that P/E is slowly inching up, the low point was more than likely an overreaction. Unless EPS drops in the third quarter, valuation should remain steady. The company still has room to improve earnings and drive the P/E ration lower, even though specialized consumer discretionary has an average valuation of 32x EPS. With strong fundamentals, I'd expect LifeLock to be on the lower end of the P/E scale.

Growth and the Future of LifeLock

One of the most important aspects in holding a small cap company is its ability to grow. For LifeLock, there are three important points to consider that justify a long position: Demographics, profitability, and potential dividend. LifeLock's business model simply boils down to the perceived fear of identity theft. When people are more generally fearful, they will tend to purchase services, like those that LifeLock provides. For LikeLock, there is a two-part benefit that deals with the younger demographic. First, Millennials have a sense of fear very similar to the Baby Boomers as a result of entering the working world during two recessions that were extremely close to one another. Second, younger people entering the working world are more technologically connected, so they are more prone to identity theft. Once they start to realize the damage that identity theft can cause, LifeLock's services will be in demand. The next consideration is the profitability of the company.

With a gross profit margin of near 74% (and growing at about 1% a year), the growth rate is healthy enough to show that management is effectively using its resources. Again, even though they have a high gross profit margin, the nature of the business is not resource intensive, so a rate like this is, to some degree, to be expected. But any doubt about management's ability to remain efficient regarding the generation of a healthy profit can be alleviated by the fact that the gross profit margin is growing at a reasonable rate.

Finally, LifeLock may declare a dividend in the near future. First, they need to keep their EPS at a positive level and they need to generate strong operating income in order to make a distribution suitable. Management has been diligent in not borrowing or using questionable accounting to support a dividend, which makes a future dividend likely and sustainable and also shows management's strength in supporting the company, as opposed to supporting the stock.

Bottom Line

LifeLock is a strong pick for the growth investor because it has a good technical entry point and it has strong fundamentals. Earnings should grow at the same clip that they have grown in the past, so investors could see close to 30% capital appreciation. Unfortunately for me, my shares were called away, so I no longer have a position. However, I could foresee myself purchasing more shares in the near future, especially after analyzing the fundamentals. Since LifeLock is already so far off its high and has begun to recover, now is a great time to buy.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.