(Published by Nicholas McCullum on April 17)
The Federal Reserve increased interest rates in March, and last December as well. Without a doubt, interest rates are on the rise.
Many investors are looking to the financial industry to capitalize on this trend. Large-cap banks like Wells Fargo (WFC, Financial) and JPMorgan (JPM, Financial) see increases in their net interest margins as benchmark interest rates move upward, which will in turn boost earnings per share and shareholder returns.
One financial stock that might not immediately come to mind is Computer Services Inc. (CSVI, Financial). While not a lender itself, Computer Services provides technology solutions to financial institutions and fintech companies.
This stock, while not exceedingly well known, has a phenomenal dividend history. The company was founded in 1965 and has increased dividends for 45 consecutive years.
Longtime Sure Dividend readers might be curious as to why the company has not been featured in our "Dividend Aristocrats in Focus" series. Recall that in order to be a Dividend Aristocrat, a company must:
- Be in the S&P 500.
- Have 25-plus consecutive years of dividend increases.
- Meet certain minimum size and liquidity requirements.
Since Computer Services is a small-cap stock with a market capitalization of nearly $607 million, it is not in the S&P 500 nor does it meet the index’s size and liquidity requirement. It does meet the Dividend Aristocrats’ most important criterion, though – at least 25 years of consecutive annual dividend increases.
You can see the list of all the ‘real’ 51 Dividend Aristocrats here.
Computer Services ranked as a top 10 stock according to The 8 Rules of Dividend Investing in the most recent Sure Dividend Newsletter. We will analyze the investment prospects of Computer Services in detail.
Business overview & current events
Computer Services provides services for regional banks, including transaction processing and compliance services.
The company recently reported a solid (but not fantastic) year for fiscal 2016. Earnings per share increased by 5% (from $1.97 to $2.07) and company-wide net income increased from $27.8 million to $29.1 million.
Other details about the company’s recent financial performance can be seen below.
Source: Computer Services 2016 Financial Summary
Because of the way Computer Services’ earnings calendar is structured, the company is well into its fiscal 2017. On Jan. 5, the company reported revenue growth of 11.9% year-over-year and EPS growth of 34.1% for the third quarter of fiscal 2017.
Computer Services will release its next earnings report in May. This will be the final earnings report for the company’s fiscal 2017. The company’s management expects “record revenue and net income” for the full-year period.
Growth prospects
As a small-cap company, Computer Services has a much higher ceiling than many of its large-cap competitors. The company continues to make acquisitions in the highly fragmented regional bank service industry. Moreover, Computer Services is often launching new services (such as new websites, mobile banking applications and due diligence tools) to improve its services to customers.
A few examples of the company’s recent acquisitions and new product offerings are:
- CSI Demonstrates Compliance Expertise in Money Services Businesses, Insurance, and Logistics With Expanded Website.
- CSI Launches Business-Oriented Mobile Banking Application.
- CSI Implements Industry-Leading Vendor Due Diligence Tool to Simplify Customers’ Compliance Reporting.
- Two Rivers Bank & Trust Selects CSI’s NuPoint Core Solution to Provide Customer-centric Banking.
These acquisitions and new products build shareholder value and increase the company’s scale-based edge over its competitors.
Competitive advantage & recession performance
Computer Service’s long dividend increase history shows the company has a durable competitive advantage. The company's trusted reputation and full-service offerings to banks increases switching costs and improves customer retention.
I would expect Computer Services to perform well in periods of economic recession for two reasons. First, the company is generally conservatively financed, which makes it unlike many of the other companies in the financial industry. Think of Computer Services as more of a services company, not a financial one.
Secondly, the company’s small size means its performance can more easily diverge from economic conditions. For Computer Services, the gain (or loss) of a large regional banking customer will likely have a much larger effect on its bottom line than changes in general macroeconomic conditions.
Computer Services’ historical performance indicates it exhibits recession-resistant traits. The company grew its EPS during each year of the Great Recession of 2008-2009 with double-digit average earnings growth:
- 2007 EPS of 94 cents
- 2008 EPS of $1.10 (17.0% increase)
- 2009 EPS of $1.31 (19.0% increase)
- 2010 EPS of $1.43 (9.2% increase)
Computer Services currently has a pristine balance sheet. The company has had no debt over the past two fiscal years.
Source: Computer Services 2016 Financial Summary
With all this in mind, I would expect the performance of Computer Services over the next economic recession to be far superior to the stock market in general.
Valuation & expected returns
The future total returns for Computer Services’ shareholders can be estimated by looking at the company’s valuation, dividend payments and expected earnings growth.
Looking at valuation first, Computer Services reported diluted EPS of $2.07 for fiscal 2016. Today’s stock price of $44.50 represents a 21.5 times multiple of 2016’s earnings. For context, the S&P 500 trades at a price-earnings ratio of 26.1 times (propped up by low interest rates).
Small-cap stocks with strong growth expectations often trade at a high valuation multiple because of their potential upside, but this is not the case with Computer Services. Accordingly, I believe the company presents reasonable value at today’s prices.
The company’s most recent quarterly dividend was paid in the amount of 28 cents. This quarterly payment indicates an annual rate of $1.12, which equates to a yield of 2.5% based on today’s stock price of $44.50.
This yield is approximately 25% higher than the S&P 500’s average dividend yield of 2.0%. The company’s dividend is also very safe, as Computer Services is currently paying out only 54% of 2016’s earnings as dividend payments.
The largest contributor to shareholder returns will be the future earnings growth of Computer Services. Over the past 10 years, the company has grown its EPS by 9.3% per year and its revenues by 7.9% per year.
Source: Computer Services 2016 Financial Summary
I expect the company’s EPS to increase by 6% to 8% over full economic cycles.
Overall, I expect total returns of 8.5% to 10.5% for Computer Services shareholders, composed of:
- 2.5% current dividend yield
- 6% to 8% EPS growth
These estimated returns are before the effects of valuation changes.
Final thoughts
Computer Services looks like an attractive stock right now. The company’s above-average dividend yield, strong historical earnings growth and low payout ratio help its rankings using The 8 Rules of Dividend Investing.
It is important for investors to recognize that Computer Services is a small-cap stock. With a market capitalization of nearly $607 million, the company might not offer the liquidity that other large-cap financial services companies do.
With that said, Computer Services remains a buy for investors that might not need the liquidity that comes from investing in blue-chip stocks.
Disclosure: I am not long any of the stocks mentioned in this article.
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