I like to buy quality merchandise at a discount. Same goes when building an investment portfolio. The idea is to buy quality companies when the market offers them at discount prices. And then a key part of the strategy is to be patient – which may mean months or years – for the market auction to bid prices back above normal valuations.
Broadridge Financial Solutions Inc. (BR, Financial) is a quality company, but the shares seem overpriced at current levels. Because foreseeable growth appears factored in at these levels, patient value investors may be well-served to wait for a pullback before taking a long-term position.
When the idea is to buy quality companies “on sale,” then two key questions must be answered when considering an investment:
- Is this a quality company?
- Is the company on sale at current prices?
This will explore those questions for Broadridge Financial Solutions.
1. Is this a quality company?
While there are many metrics to define the quality of a company, a focus on fundamentals is a good starting point. In particular, a focus on historical growth in metrics such as per share revenue, earnings, dividends and book value offers insight into the likely quality of a company.
While the past is certainly no guarantee of future results, it is helpful to understand a company’s past performance on business fundamentals across multiple business cycles. To visually review data on historical per-share growth trends, I like to use my F.A.S.T. Graphs subscription and the F.U.N. Graphs feature to gain a deeper understanding of the company.
Revenue per share
Because Broadridge Financial Solutions was spun off from Automatic Data Processing (ADP, Financial) in 2007, the data reflects the time period from 2007 until today. As we can see in the graphic below, Broadridge Financial Solutions has delivered steady revenue growth during the period under review.
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
History of EPS growth
Another fundamental metric to review is the history of earnings per share performance. Per the graphic below, Broadridge Financial Solutions has delivered reasonable earnings growth since 2007.
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
Dividend growth
Dividends are functions of earnings; as such it is helpful to review the dividend growth history of Broadridge Financial Solutions to understand the strength of its underlying fundamentals. As the graphic below demonstrates, Broadridge Financial Solutions has consistently rewarded shareholders with steady dividend growth over time.
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
The growth of book value per share
This difficult-to-manipulate metric offers an understanding of management’s ability to grow book value over time. Again, in my view Broadridge Financial Solutions has done a notable job in growing book value over the past eight-plus years
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
Based on a review of historical fundamental metrics, Broadridge Financial Solutions is a quality company that has delivered results over multiple years.
2. Is the company on sale at current prices?
Say we believe Broadridge Financial Solutions is a quality company. That’s part of the story. In order to have full insight into any possible opportunity, we need to complete the story by reviewing the price-to-value relationship.
When valuing a company, I pay close attention to that company’s own historical valuation as measured by its own P/E ratio and then take action when the price is reasonable relative to earnings. Once again, F.A.S.T. Graphs is helpful to get a visual of the relationship between price and value. In the chart below, the orange line represents earnings history and what could be considered "fair valuation" at a price-to-earnings multiple of 15x. The blue line represents an historic normalized average P/E. Finally, the black line is the market price.
Looking carefully at the graphic below, we can observe that the historical normal P/E is 14.9x earnings. Broadridge Financial Solutions is priced at 21.1x earnings. This is easily seen by looking at the black price line compared to the blue P/E line. In other words, the black price line is above the normal P/E and reasonable valuation lines. This demonstrates that Broadridge Financial Solutions is overvalued relative to its earnings. Even if the company is not overvalued, it certainly is not on sale at a steep discount.
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
A reasonable entry point to consider
Assuming we believe Broadridge Financial Solutions is overvalued and not on sale right now, what might be a reasonable discount price to consider? Assuming an average P/E ratio of 14.9x and applying the forward estimated earnings of $3.10, then an entry point closer to $46 may be reasonable for patient investors who desire to add this company to their portfolios.
Recap
Broadridge Financial Solutions is a company with a solid history of fundamental metric growth, and it has a variety of efforts under way to support growth going forward. However, based on this company’s own history, shares seem overpriced at these levels. The current P/E is 21.1x when Broadridge Financial Solutions’ own normalized PE is 14.9x. Patient investors may be well-served to wait for a lower entry point.
