Ebix Inc. (EBIX) is a supplier of software to the insurance industry and has been experiencing phenomenal growth over the past several years. The company still has a market capitalization of under $1 billion, yet has offices worldwide and is making strategic acquisitions very frequently to bolster its position and expand into new markets and services. As of Friday's (09/07/2012) close, Ebix was trading at a price of $24.44 per share. My investment strategy is to buy high quality companies when they are trading at a significant (> 25%) discount to their intrinsic value. Is Ebix currently a bargain? Let's find out.
First, let's establish that Ebix is in fact a quality company, that can be expected to perform consistently in the coming five years. Quality is defined by the company's ability to meet a number of criteria with respect to consistent growth and return on capital. Specifically, we look at the following metrics:
- Return on Invested Capital [ROIC] > 10%
- Earnings per Share [EPS] growth > 10% annually
- Sales growth > 10% annually
- Equity growth > 10% annually
- Long term Debt < 3 years of current earnings
Companies that are able to meet these criteria consistently over a long period of time are likely to be more predictable, and this is key to us being able to develop a proper valuation of the company with a strong degree of confidence.
ROIC for last year was 17.1% and the average over the past five years was 25.6%. These both surpass our minimum requirement of 10%. ROIC is an important number because it tells us how well the company's management is putting money to work.
EPS Growth over the past several years is shown in the following table:
|Year||EPS ($)||EPS Growth (%)|
EPS growth has surpassed our minimum requirement of 10% per year by a huge margin for every year since 2005. Average EPS growth over the past five years is 55.7% and is an average of 78.4% over the past 10 years.
Sales growth over the past several years is shown in the following table:
|Year||Sales (millions)||Growth (%)|
Sales are growing at a rate that exceeds our minimum requirement of 10% per year for the past several years. Average sales growth over the past five years is 65.5% and is an average of 77.9% over the past 10 years. This is excellent from the point of view that sales are growing very consistently, and at a high rate.
Equity Growth over the past several years is shown in the following table:
|Year||BVPS ($)||Growth (%)|
Equity is growing at a rate that exceeds our minimum requirement of 10% per year for the past several years. Average growth over the past five years is 57.7% and is an average of 52.2% over the past 10 years. Again, excellent and very consistent year after year.
Long-term debt as of the most recent annual report stood at $40.22 million. Based on annual earnings of $71.38 million, it would take 0.56 years to pay off the entire debt if all earnings were allocated as such. This is well within our criteria that debt be capable of being paid off with 3 years of current earnings.
Summary: Ebix meets all of our criteria for a high-quality company that will allow us to calculate a valuation in a predictable manner. EPS, sales, and equity are all growing year after year at a rate that exceeds our minimum requirements. This is a result of management putting capital to good use, as evidenced by the high ROIC. Finally, the company is able to achieve this without relying heavily on external financing (low debt).
Our method for calculating the intrinsic value of Ebix is by using the expected future EPS growth for the next five years, an estimated future P/E ratio, and finally a minimum acceptable rate of return (MARR) that we desire to achieve. Also required is the trailing twelve months EPS number to use as a starting point. We use these numbers to calculate the future value (FV) and subsequently the present fair value of the company.
Future EPS Growth: Analyst consensus is that EPS for Ebix will grow at a rate of 20.0% over the next five years. Does this make sense? EPS growth over the past five years averaged 55.7% and grew 15.9% last year. Sales and equity grew at average rates of 65.5% and 57.7% respectively over the past five years. Despite the drop in EPS growth in 2011, I am going to use the analyst consensus of 20% EPS growth rate over the next 5 years for our calculations.
Future P/E Ratio: The future P/E ratio is most easily estimated by looking at historical values and trends. The following table summarizes the average P/E ratio for each of the past several years:
|Year||Avg. P/E Ratio|
The average P/E ratio over the past ten years was 12.7 which is slightly lower than the current P/E (as of today) of 14.3. This seems like a reasonable value to use for our calculations.
Future/Present Value: To calculate the future value, we also need to determine the EPS for the trailing twelve months and our MARR. Ebix earned $1.71 per share over the past year so we will use this number as the starting point in projecting future earnings. We will use a MARR of 15% as this is the compounded return we aim to achieve. A 15% annual return doubles the original investment in five years time.
Our inputs to the value calculations are then as follows:
- EPS [ttm]: $1.71
- Future EPS growth rate: 20.0% / yr
- Future PE ratio: 12.7
- MARR: 15%
A future value calculation predicts an EPS of $4.26 in five years' time. Using a future PE ratio of 12.7, this results in a predicted future share price of $54.04 in 2017.
The final step is to calculate the present value of the stock. We now use a present value calculation with the future share price determined above, and our MARR of 15%. The result of this calculation is a current intrinsic value of $26.87 per share. In the interest of keeping the calculation simple (and somewhat conservative) we have not allowed for other factors such as dividend payments in the calculations.
Entry Price Target
In the preceding section we determined that Ebix is currently valued at $26.87 per share. As of Friday's close, it was trading at $24.44 per share, which represents a 9% discount to its intrinsic value. This is close enough to say that Ebix is fairly valued at current price levels.
My strategy is to attempt to purchase stocks at a discount to their fair value (normally at least 25 - 30%). My entry price target for Ebix is therefore $18.81 to $20.51 per share. Ebix was trading at this level as recently as June of this year, so a drop back to this level is not out of the question in the near future.