Here's Why I Am Adding Equifax To My Watch List

Summary

• Equifax is a large global player in the realm of risk assessment.
• Post-recession attitudes demand prudence in evaluating loans and serve as a driver for the company’s fundamentals.
• Equifax sports strong fundamentals.

It's important for long-term investors to develop a guide for doing their investment research. Over the years I have developed six questions to guide me in my thinking when researching the publicly traded universe. Today let's talk about Equifax (NYSE:EFX).

1.) What does the company do?

When you buy shares in a company you effectively become part owner of that company. Therefore, it's important for an investor to understand what a company sells. Equifax essentially resides in the business of information and analytics. The company is most well-known for its credit reporting services.

Equifax provides credit data to banks, employers, and individuals to help them assess risk. It also provides fraud and identity management, as well as employment verification services. Equifax provides prudent companies or individuals the ability to assess risk within their own business, or personal financial situation, and related to their customers and suppliers.

2.) What do the fundamentals look like?

Investors should also look for companies that grow revenue and free cash flow over the long-term, retaining some of that cash for reinvestment back into the business and for economic hard times. Excellent revenue and free cash flow growth serve as catalysts for superior long-term gains. Equifax expanded its fundamentals at a decent rate over the past five years. Its revenue, net income and free cash flow grew by 42%, 47% and 129%, respectively (see chart below).

Many factors contributed to Equifax's expansion in fundamentals. Increased economic activity, and the related need for more prudent decision making on potential loans, contributed to the expansion in fundamentals. Moreover, Equifax continues to look for better ways to serve its clientele. Its management isn't afraid to make strategic acquisitions to add to its product portfolio and enhance its market position.

In the most recent quarter, Equifax continues executing well. The company saw revenue expansion in many of its businesses according to its latest earnings announcement. It grew its revenue, net income and free cash flow 12%, 5% and 53%, respectively, year-over-year. Equifax sits on an ok balance sheet. In the most recent quarter, Equifax possessed $95 million in cash and equivalents, which equates to only 4% of stockholder's equity. I do prefer to see companies with cash amounting to 20% or more of stockholder's equity.

I don't like debt. Long-term debt creates profit choking interest costs. I prefer to see companies with long-term debt amounting to 50% or less of stockholder's equity. In the most recent quarter, Equifax's long-term debt amounted to 52% of stockholder's equity. In FY 2014, Equifax's operating income exceeded interest expense by nine times, which is reasonably above the rule of thumb for safety of five times or more.

3.) How much management-employee ownership is there?

Investors should always look for businesses where the managers and/or employees own a lot of stock in the company. Managers with a great deal of stock in the company will take better care to maximize company profits, which will enhance share price and their personal wealth along with the wealth of shareholders. According to Equifax's latest proxy, no executive or employee owns more than 1% of the company. This doesn't necessarily mean it's a bad thing; it just means no one among senior management has the extra incentive provided to someone who owns a great deal of stock in the company.

4.) How does its "Report of Independent Registered Public Accounting Firm" stack up?

Every year a company employs external auditors to audit financial statements and evaluate whether it maintains adequate financial controls. At the conclusion of the audit, you want to see a letter from auditors with the language "unqualified" or "fairly presents", which generally means that the financial statements and internal systems in constructing them were clean or adequate. If you see "qualified" or "adverse" in the auditing letter's language then deeper issues in a company's financial statements may exist.

In FY 2014, Equifax's auditors gave its financial statements an unqualified opinion and stated that the company maintained adequate internal controls. However, it didn't include the financial statements and internal controls of TDX Group, which it acquired in FY 2014. This is typical during the year of an acquisition.

5.) What types of risk does it have?

It's always important for investors to weigh the various risks, such as exposure to political risk in parts of the world where war is the norm, competitive positioning, and market price risk. Equifax is a global company, which means it possesses some political risk. As an example, adverse foreign currency translations serve as a drag on revenue growth so far in FY 2015.

Equifax belongs to an oligopoly of huge credit and analytic companies. It competes with companies such as Transunion (TRU) and Experian (OTCQX:EXPGY). However, it would require a new competitor a great deal of investment in technological infrastructure, relationship building and marketing to get established and effectively compete with a company like Equifax.

Equifax comes with high market price risk. The company currently trades at a P/E ratio of 33 vs. 19 for the S&P 500 as a whole, according to Morningstar.

6.) What does its forward analysis look like?

Equifax should continue to do well on a fundamental basis as long as the economy keeps expanding and people need loans and employment verification. Actually, the company has demonstrated remarkable resilience during recessions due to its toll bridge status. Even at a slower economic pace, businesses and individuals rely on Equifax to assess loans and other types of risk. However, due to Equifax's high P/E ratio, I will simply keep an eye on this company for now while waiting for a lower valuation. Investors who can stomach some volatility may want to take the plunge.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.