Today we made the decision to sell an individual position as well as add a new holding to the Nintai portfolio. We will be selling our entire position in Factset Research Systems (FDS, Financial) and taking a new position in Computer Modelling Group (CMDXF, Financial).
Sell: Factset Research Systems (FDS, Financial)
We have owned Factset since June 2005 and have achieved a 315% return since purchase. We still believe Factset is a fantastic company – 42% ROE, 33% ROA and 47% ROIC. We simply can’t see a way to achieve an adequate return going forward at this price. In our estimates the company is trading at roughly a 40% premium to intrinsic value.
In a recent article by The Science of Hitting (“Part Four: A Continuing Discussion On Intrinsic Value”), Jean-Marie Eveillard (Trades, Portfolio) of First Eagle Funds was quoted as saying,
“A key question, if one adopts more or less the Buffett approach, is if the stock moves to what you think is the intrinsic value of the business, does one sell automatically? Some value investors say ‘yes, you have to sell, because it is fairly valued now.’ My point is, if it’s modestly overvalued or moderately overvalued and if you think you have a business that is really compounding, that creates value successfully over the years, you’re probably better off holding on to it – and accept the fact that maybe for awhile the stock does not go up, as the profits have to catch up with the price of the stock…”
To a point we agree with this. We actually were quite happy to hold FDS at a 10 -15% premium to fair value simply because of the compounding capability of the company. But more importantly we agree with Science when he wrote:
“When someone says that a business has reached / exceeded fair value but they’re still holding on because it’s a great business, what I really hear is that it may appear expensive at first glance, but the fundamentals actually justify the current valuation (if not higher). Said differently, the stock isn’t actually overvalued – it just appears so on simplistic measures of intrinsic value like the current P/E versus the market multiple”.
We believe this represented FDS as it reached its level of 10-15% above our fair value but no longer at a 40% premium. Accordingly we are exiting our position.
BUY: Computer Modelling Group (OTC:CMDXF)
CMDXF develops and delivers reservoir simulation technologies to assist oil and gas companies in determining reservoir capacities and maximizing potential recovery. With petroleum production using conventional methods on the decline, the petroleum industry must use more difficult and costly advanced process extraction methods, while being faced with more governmental and regulatory requirements over environmental concerns.
Computer Modelling is the type of company we love to partner with in the long term. High returns on equity, assets, and capital. Steady revenue and free cash flow growth. High free cash flow as a percentage of revenue. No debt. Trading at a significant discount to fair value. Just about all our investment check list has been met.
The company’s stock is down -27% in the last year reflecting the market’s general disdain for anything related to petroleum.
The company has grown revenue from $12.5M in 2005 to $67M in 2014 (and an estimated $75.8M in 2015) or roughly 17% growth annually over the past 10 years. Free cash flow has grown $2.4M in 2005 to $28.8M in 2014 (and an estimated $31.7M in 2015) or roughly 28% growth annually over the past 10 years. Earnings per share have grown roughly 36% annually over the past 10 years. The company has no short or long term debt and roughly $65M cash on the balance sheet.
Since 2005 the company has averaged a 47% return on equity, 29% return on assets, and 51% return on capital. The stock currently yields 3.5%.
We currently estimate an intrinsic value of roughly $13/share or a 22% discount to its current price of roughly $10/share as of February 19th, 2015.
Conclusions
In the final analysis this about replacing an asset that is highly overvalued with an asset trading at a discount to fair value. This transaction increases our chances at producing adequate returns for our investors in the long term. While it’s difficult to let go of a company that has produced extraordinary returns for us, the ability to be objective (discussed in our article “Compounding or Confounding: The Agony of the Sale”) and make the sale is vital to achieving returns above and beyond our index proxy. We do this rarely simply because the companies we choose to invest with are generally long term compounding machines. But when Mr. Market offers you a price far in excess of your estimated intrinsic value your inability to sell is usually based more on speculation than investing.
We are happy to share our valuation summary spreadsheet in case anyone would like to review. As always, we look forward to your thoughts and comments.
