Five simple screens can be used to evaluate Accenture PLC (ACN, Financial). These screens were carefully chosen based on the work of many of the world’s best investors and, in particular, Seth Klarman (Trades, Portfolio), Warren Buffett (Trades, Portfolio), Charlie Munger (Trades, Portfolio) and Peter Lynch.
These investors have spent years refining and educating others – in books, commentaries and annual reports – on what they’d consider the fundamental principles of investing. These men have hundreds of years of collective experience, they have back-tested countless trading strategies, and they have put their and their families' money on the line.
As most people are already aware, their investment results have been very impressive. Many investors who followed duplication strategies based on the known holdings of these greats have also never been happier. Thank you, GuruFocus!
These screens, when you look at them on paper, obviously appear to be an enormous simplification of the thought processes employed by these men when making their investment decisions. Nonetheless, we’ve spent years running the screens and, for us, they have flagged some really good investments. The five simple screens include:
- Does the business have a sustainable competitive advantage?
- What is the company’s free-cash-flow-to-the-firm (FCFF) yield?
- What is the company’s return on invested capital (ROIC) and how does it compare to the company’s weighted average cost of capital (WACC)?
- Can the company easily manage its debt with earnings and operating cash flows?
- Is it trading close to its 52-week low?
Let’s see whether Accenture PLC passes the five screens and whether we can expect it to yield acceptable results.
Company overview
Accenture is engaged in providing management consulting, technology and outsourcing services. The company’s business is structured around five operating groups, which together consist of 19 industry groups serving clients in industries globally.
The company’s segments include Communications, Media & Technology, Financial Services, Health & Public Service, Products and Resources. The Communications, Media & Technology segment serves the communications, electronics, technology, media and entertainment industries. The Financial Services segment serves the banking, capital markets and insurance industries. The Health & Public Service segment serves health care payers and providers, government departments, public service organizations, educational institutions and nonprofit organizations. The Products segment serves consumer-relevant industries. The Resources segment serves the chemicals, energy, forest products, metals and mining, utilities and related industries.
Screen 1: Sustainable competitive advantage
Does the company have a sustainable competitive advantage? Absolutely.
For one, the company operates on a huge scale, has a massive international network and serves almost all of the world's largest companies. Few other consulting firms can operate at the same scale, and this gives them both a cost advantage and additional negotiating power with clients. Two, the company has a phenomenal reputation and carries substantial brand strength. In fact, Accenture is consistently ranked as one of the top 100 brands in the world and has won buyer’s minds as a “best choice” for consulting service. Three, and perhaps most important, Accenture employs some of the world’s highest quality consultants. Just go to a meeting with some of its senior staff, and you’ll quickly see how sharp they are. They know business, they know technology, and as a client hiring Accenture for its assistance, you’ll quickly see how its consultants can turn your business into a success.
Accenture’s top quality consultants help it to attract and train talented graduates and junior consultants from other firms. This is evident in their high university recruitment rates and employee retention rates. They also help to build switching costs. Client relationships are invaluable; once they’ve been formed and proven to be mutually beneficial, customers will hire them again and again.
Because Accenture is involved in almost all lines of business and has consultants specializing in almost all types of technology and operational processes, it can bundle its services and offer customers a one-stop shop for consulting. This gives additional pricing and service advantages over a lot of the competition.
Screen 2: Free-cash-flow-to-the-firm yield
FCFF is the amount of cash that a company has left over after it has paid all expenses, including net capital expenditures. Net capital expenditures are what a company needs to spend annually to acquire or upgrade physical assets such as buildings and machinery to maintain and grow company operations. FCFF is the cash available to all investors, both equity and debt holders and, as such, it is calculated by subtracting net capital expenditures from operating cash flows and then adding back after-tax interest expenses.
FCFF = Cash flows from operations – net capital expenditures + [Interest expense x (1-tax rate)]
FCFF measures a company's ability to pay down debt, increase investment and increase shareholder value.
A firm’s FCFF yield is calculated by dividing FCFF by the company’s enterprise value.
FCFF Yield (%) = FCFF/Enterprise Value
A firm's FCFF yield represents the rate of return that an investor could expect to receive for purchasing the company outright, paying off its debts and taking it private. Firms with high FCFF Yields are, from a purely business owner’s perspective, great companies.
Accenture is currently producing an FCFF yield of 6.5%. To eliminate the effects of abnormally high or low current yields, we normalize using a three-year moving average, which is 6.6%. We are looking for a positive spread over the long-term government bond yield of 3.5%. Accenture provides us with a reasonable margin of safety offering a yield spread of 4.3%.
Figure 1: FCFF Yield (%) — Three-year moving average
Screen 3: Return on invested capital
One of the best ways of assessing the strength of a firm is to evaluate whether the company has produced a history of positive residual income. When doing this, it is useful to look at (1) the spread between the firm's return on invested capital (ROI) and weighted average cost of capital (WACC) and (2) the spread between the firm's return on equity (ROE) and required rate of return on equity (Re) over as long a period as possible.
Based on the numbers, Accenture appears to be a very strong company. As can be seen in Figures 2 and 3, Accenture has cranked out substantial residual income over the past decade, with an average ROI-WACC spread of 51% and an average ROE-Re spread of 54%. Wow!
Figure 2: Return spreads (%)
Screen 4: Manageable debt
Accenture can easily manage its debt load: it has a long-term debt-to-asset ratio of less than 1%, a debt-to-equity ratio of 0.5% and an interest coverage ratio of more than 250x. In addition, the company has a debt-to-earnings ratio and a debt-to-operating-cash-flow of less than 1.5x, which means that it would take the company less than two years to pay off all its debt in the case of an emergency.
Screen 5: Near a 52-week low
As explained by Seth Klarman (Trades, Portfolio), to identify undervalued positions, look for companies trading near their 52-week lows. Is Accenture trading near its 52-week low? Absolutely not. Accenture is up about 19% this last year from its 52-week low.
So what do we do? Does Accenture make for a good investment decision? Well, over the last year the stock has appreciated by about 12%. Over the last five years it has appreciated by 104% and over the last 10 years it has appreciated by 218%. Trading at 21x TTM EPS and 18x forward EPS, it’s probably about fairly valued at its current price.
And what about market sentiment? Well, you can guess it. Market sentiment remains very bullish. As can be seen below the firm’s short position just continues to fall.
Conclusion
Accenture appears to be about fairly valued with investors everywhere cheering for the company. Does this render our analysis pointless? Absolutely not. There is major turmoil brewing in international markets right now. Economists all over the world are downgrading growth projections and expected index returns.
That being said, who knows to what extent a market drop could pull Accenture down with it? If the stock price does fall, hopefully you’ll feel a little more comfortable pulling the trigger and buying it. As four of our screens showed, this is an outstanding company – a gem, in fact – and should be on all investor’s radar screens.
