New Threads Only:  Add to Google Reader or Homepage
New Threads & Replies:  Add to Google Reader or Homepage
Forums are for serious investors only. GuruFocus Forum Rules.

Forum List » Value Ideas and Strategies
Share and discuss value investing ideas and investing strategies.
New Topic Search
Goto Thread: PreviousNext
Goto: Forum ListMessage ListNew TopicSearchLog In
The Magic Commtouch?
Posted by: Barel Karsan (IP Logged)
Date: May 31, 2012 11:03AM

As discussed at ShadowStock, Commtouch (CTCH) has all the makings of a stock trading at a discount to its intrinsic value. The company trades for $65 million despite net cash of $22 million and net earnings of $16 million over just the last four years, resulting in an average ROE of about 20% over this period. Commtouch remains profitable, having earned another $1.2 million in its latest quarter.

Commtouch provides security and antivirus software for deployment on routers and other network equipment. As the company has been growing revenue and earnings steadily at excellent levels of ROIC, it trades at a price to book ratio above 2. As such, potential investors in this stock should be sure to ascertain the sustainability of the company's earnings before jumping in; if earnings collapse, there aren't enough assets (e.g. cash, land, inventory etc.) to fall back on to protect the investor on the downside.

How sustainable are earnings in the software industry? The answer varies considerably from company to company. Because hardware improvements (both in performance and price) occur quickly, software companies must constantly keep programs up to date to keep pace with competitors. In this sense, software is one of those fast-changing industries that is best avoided.

But at the same time, certain software applications have a customer stickiness to them that provides incumbents the ability to remain leaders while enjoying strong capital returns. Oracle's databases may be such an example, as the integration of Oracle's systems with the rest of a company's infrastructure would create large costs for a company looking to switch. Microsoft's Office enjoys a different type of advantage, with the same effect of customer stickiness. Users are loathe to switch to a new or different application, as it is a priority to be able to create documents in formats that can be easily shared, creating a network effect.

So where does Commtouch fall on this scale? Commtouch's numbers clearly suggest a competitive advantage is present. However, from what I can tell, Commtouch doesn't appear to integrate deeply into its customers' infrastructure with the majority of its offerings. It sells its software to original equipment manufacturers that then sell solutions to network customers. If a competitor came out with a better mousetrap (i.e. one that filters spam in a more customized way or recognizes malware more quickly with fewer false positives) or the same mousetrap at a better price, I'm not sure what prevents the customer from switching.

But just because Commtouch may be out of my circle of competence doesn't mean it's out of yours. If you can spot an advantage that Commtouch is exploiting that is allowing it to earn outsize returns, this stock may be worthy of your portfolio at its current price. The company trades at less than 10x this year's earnings (ex-cash), suggesting shareholders will make out very well if its earnings are sustainable.

Disclosure: No position


Stocks Discussed: CTCH,
Rate this post:

Rating: 3.4/5 (9 votes)



The Magic Commtouch
Posted by: shadowstock (IP Logged)
Date: May 31, 2012 11:06PM


Thanks for the blog mention!
John


Stocks Discussed: CTCH,
Rate this post:

Rating: 3.0/5 (1 vote)





Sorry, only registered users may post in this forum.

Please Login if you have an account or Create a Free Account if you don't
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK