Shares of F5 Networks Inc. (NASDAQ:FFIV) are down 13.92% since peaking on September 28, 2018, and in my opinion, the shares of this provider of software-defined applications for security, availability, and network storage systems are a Strong Buy at current price levels. The company has a solid history of generating impressive earnings growth, and the future growth ratios point to continued growth over the next twelve months. I lay out my bullish argument for the company below by reviewing some pertinent fundamental and technical aspects of the stock.
Momentum Growth Quotient
My Momentum Growth Quotient (MGQ) plays a critical part when it comes to determining whether I am going to go long or short a stock. Generally, I only want to go long a stock with an MGQ higher than that of the S&P 100, and I want to go short a stock with an MGQ lower than that of the index (for a more detailed explanation of how I calculate the MGQ, please see my blog post).
As of the end of October 2018, the MGQ for the S&P 100 was 9.21.
The current MGQ for FFIV stands at 12.83, which implies a 39.37% higher growth rate compared to the S&P 100. This tells us that FFIV has strong future growth potential and is a good candidate for a long position.
Let's dig a little deeper into the financial data to get a better feel for how the company has performed on certain fundamental metrics and what these numbers imply for future growth.
Caveat Lector: I am Quant Trader - i.e., I seek to understand market behaviour by using mathematical and statistical modelling, measurement, and research. So, you won't find much qualitative analysis in my work or in my trading process. The goal is to identify optimum entry points for trades based on my quantitative model and execute those trades as effectively as possible.
During the past 12 months, the average EBITDA per Share Growth Rate of F5 Networks was 9.50% per year. During the past 3 years, the average EBITDA per Share Growth Rate was 8.90% per year. During the past 5 years, the average EBITDA per Share Growth Rate was 12.20% per year. During the past 10 years, the average EBITDA per Share Growth Rate was 21.20% per year. (Source: GuruFocus). Earnings growth for the company has been impressive over the past ten years.
The operating margin % for FFIV stands at 30.57%. Each dollar of revenue the company generated brought in 30.57 cents of earnings. Its 5-year average operating margin stands at 27.77%, which compares very favourably to the industry average of 8.94%.
Knowing how a company has performed in the past is important in order to evaluate management's past record in running the business. But more important to us is how profitable the company will be in the future, because we are investing going forward, not backward. And it's the forward-looking metrics that should really get you excited about FFIV.
I like to use two measuring sticks to gauge the future growth potential for companies: forward P/E and forward rate of return.
I prefer to use the forward P/E ratio (the current stock price over "expected" earnings per share) rather than historical P/E to gauge a company's expected future earnings power. A high forward P/E ratio means that investors are anticipating higher growth in the future and are willing to pay more for future earnings - momentum investing is all about following the trend (perceived or real).
FFIV has a forward P/E of 16.18, compared to a 17.10 forward P/E for the S&P 100. The Forward P/E for FFIV is slightly lower than that of the index, indicating that investor growth prospects for the stock are a bit lower than that of the broader market, but I view any forward P/E over 10.00 as acceptable for a long position.
The forward rate of return for a stock (created by Donald Yacktman) is one of my favorite quotients for gauging the market's expectation for future growth of a company. Yacktman defines forward rate of return as the normalized free cash flow yield plus real growth plus inflation. In simple terms, the forward rate of return can be thought of as the return that investors buying the stock today can expect from it in the future.
The forward rate of return for FFIV stands at 16.98%. This implies that an investor buying the stock today should expect a 16.98% return over the next 12 months. The average forward rate of return for the S&P 100 as of the end of October was at 8.03%, so FFIV has an implied potential rate of return that is 2.11x greater than that of the index.
The risk inherent in the forward rate of return is that the calculation is reliable only if the company can grow at the same rate in the future as it did in the past. If its growth rate falters, the projected returns will not materialize. But we are willing to accept this risk as part of the difficult process of forecasting earnings and growth momentum.
As per my ChartMasterPro Daily Trade Model, there is a high probability of a rally to the $190.00 level from here, which represents a gain of 10% for the shares.
- The RSI 14 recently broke above 50.00 recently, and looks poised to make a run back above this level.
- The MACD is rising on the verge of turning positive (bullish momentum signal).
- The shares found support at the 50ma and set a higher low on its most recent pullback - a bullish price pattern.
I will buy call options for FFIV to participate in the anticipated run to $82.00. To view the option details (strike price, expiry date, and leverage), you can sign up for a Free Trial for The Options Trader. Only members receive detailed trade alerts.
For investors in the shares, I recommend that you hold for 3 months or $190.00, whichever comes first. For longer-term investors, I believe FFIV is a solid addition to any growth portfolio over the next 12 months.
When looking for companies to invest in, I like to find ones with a management team that has outperformed the peers in the same industry with regard to effectively turning revenue into profits and generating superior returns for shareholders.
|Gross Margin TTM||83.24%||32.18%|
|Net Profit Margin TTM||21.96%||10.01%|
|Net Profit Margin 5-year Avg.||19.57%||8.78%|
Return on Equity - 5-year Avg.
FFIV is a company that with a management team that is very good at throwing dollars to the bottom line compared to its peers and generating higher-than-average returns on equity.
Profit Margins Back in an Uptrend
The chart below shows the company's gross margin TTM trend over the last five years - you can see that the trend peaked in early 2017, and continued to fall to the end of that year. But it started to trend higher at the beginning of 2018, and continues to trend higher - this is excellent news, as this company thrives on higher margins, as do the shares. The recent price drop in shares presents an excellent opportunity to initiate a position in FFIV.
When I go long a stock, I want to invest in a company that provides superior future growth potential, but I also want to time the entry into any position to try and maximize my return. So, I use fundamental analysis to identify shares with a strong future growth rate, and then I apply technical analysis to identify ideal entry points.
In my opinion, FFIV is a compelling buy at these levels from both a fundamental and technical perspective.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FFIV over 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.