Software Giant SAP Is A Worthy Investment

| About: SAP AG (SAP)
If you want to achieve above-average market returns, then you can’t just invest in an index fund. For those willing to venture outside those index funds, there are three principles you should keep in mind:
  1. You will have to accept less diversification than the market;
  2. You must recognize that short-term speculative trading normally ends with your money in someone else’s pocket;
  3. You must be willing to take a contrarian stance against the majority of investors.
Perfect diversification is impossible. There are simply too many investment options for investors to cover, and not enough money to buy them all -- not to mention perfect diversification would net zero gains. Short-term trading is a losing game, especially in the long run. If you think you can win consistently enough using this strategy, you are exhibiting one of the great problems of humankind: overconfidence. The third principle provides investors the best opportunity to earn better-than-average returns – they must be willing to take a contrarian stance against the majority of investors.
So what would be considered a contrarian play in today’s market? Well, based on the flow of funds out of common stocks, it is common stocks, of course! To extend the contrarian play even further, you would look for shares of common stocks in European countries. If you wished to push that contrarian element to the extreme, you would buy stock of a European company with revenues provided by uncertain governments, educational institutions (that are themselves supported by those governments), and a number of large corporations that are currently scared to spend their cash, for fear of those governments’ instability.
Yet I don’t feel that our recent purchase of SAP AG (NYSE:SAP), the German software giant, is such an extreme example. SAP’s business software is used to manage core business functions, which is exactly what governments and large corporations are seeking in their quest for lower costs and higher productivity. As companies find out it is less expensive to outsource their software needs to a packaged application, instead of maintaining those functions in-house, SAP benefits.
But SAP has something else to offer that could have a meaningful impact on its future earnings: It is a leader in mobile technology. Because of the need to secure the private information of their company and customers, many businesses have been slower to adopt this technology than have the countless individuals walking about with devices in hand. SAP is offering a new rapid-speed product for mass data analysis, called SAP HANA. When you combine it with its Afaria product to secure enterprise data on mobile devices, and its Sybase mobile computing offering, SAP can offer a secure system that can reach 96% of the world’s mobile population. Once businesses realize they have the ability to securely, at any time and in any place, communicate, market to and transact with their consumers at a lesser cost, a purchasing avalanche could easily happen.
It looks as if these offerings have already begun paying off. On October 14, SAP reported that its third-quarter operating profit more than doubled from the previous year, while revenues increased 14% to 3.41 billion euros. Although the company produced these exceptional results, it also stated that its full-year outlook will remain unchanged, “due to the ongoing uncertain macroeconomic environment.” It is the negative connotation of this statement (basically the same stock phrase countless other companies are delivering with earnings) that has created the bargain we believe SAP shares offer today.
SAP AG ADRs are trading at 17.65x 12 month trailing earnings of $3.38 and just 14.14x consensus 12 month forward earnings of $4.22. Over the past 10 years the company has grown its shareholder equity by 18.77% compounded per year. The company’s return on equity has averaged 24.83%, and return on invested capital is almost identical at 24.29%, reflecting its strong financial controls and conservative balance sheet. Compared to others in its industry group, SAP shares trade at a discounted P/E with an equivalent growth rate. We have placed fair value at $75.96 or 18x forward earnings, some 27% above the current price.

Disclosure: I am long SAP. I own shares of all companies mentioned.
Disclaimer: Any opinion and/or information contained in this commentary are derived from sources believed to be reliable, but Kendall J. Anderson, CFA or Anderson Griggs Portfolio Management cannot make representation as to its accuracy or completeness. This commentary does not specifically address individual investment objectives, and any conclusions may not be suitable for you. As in all common stock investing, you can incur a profit or loss of capital. Past performance should not be taken as an indication or guarantee of future performance.

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