The Nasdaq has plenty of names within the mid-cap and small-cap space that have fantastic margins, enviable revenue growth and decent valuation multiples but weak stock performance. In the end, it is all about market perception, and many companies are unable to communicate their future potential effectively to the investor community, resulting in a mediocre stock appreciation. A wonderful example of this is Israel-based IT security player Check Point Software Technologies (CHKP, Financial).
What does Check Point do?
Check Point offers a wide range of products and services catering to network security, endpoint security, data security and management solutions. Some of the core products in its portfolio include Infinity Architecture for protection against major cyber-attacks, SandBlast for threat prevention (including a mobile version for iOS and Android) and CloudGuard for the security of enterprise cloud networks.
Founded in 1993 in Tel Aviv, Israel, the company has come a long way in building its product portfolio and has an excellent support infrastructure in place for implementing, upgrading and optimizing its products. Check Point’s biggest markets include enterprises, service providers, SMEs and direct consumers (which they are able to reach through a network of channel partners).
Financials are Check Point’s biggest forte
It is rare to find a company that has been consistently beating analyst estimates on the revenue front as well as the earnings front for almost two years. Check Point is one such company that outperformed once again in its most recent results, when it reported a top-line of $543.8 million, marginally above the analyst consensus estimate of $543.27 million. This was driven largely by the strong growth in the security subscription business, which now accounts for $164 million of the total revenues.
Check Point’s largest business segment, maintenance, also showed growth of 2%, and its cloud market penetration increased to about 2,500 customers. The company made two small acquisitions during the quarter, Cymplify and Protego, but they were small in size and most of the revenue growth was organic.
In terms of profitability, the management reported earnings per share of $2.02, which was again above the analyst consensus estimate of $1.99. The company was able to generate a significant amount of free cash flows as a result of its operating margin of 44.2%, which is why the management has gone ahead and announced an additional $2 billion share buyback program with a quarterly repurchase of $325 million. It must be noted that the company is debt-free and has a return on equity of 22.52%.
Check Point’s stock has been more or less flat during the year, thanks to the market valuing it by focusing on its revenues rather than free cash flows. Admittedly, the company’s enterprise-value-to-revenue ratio of 8.18 is quite high, but with the kind of margins and EBITDA-to-free-cash-flow conversion that it has been able to deliver, its price-to-free-cash-flow ratio of 16.3 is well below the industry average for the software industry. Given the annualized EBITDA growth of 4.2% for the past three years, there is certainly a lot of scope for a multiples expansion and price appreciation in this regard.
The company has a 4.5-star business predictability rating and a 10 out of 10 profitabilty rating on Gurufocus, which are good signs for its future.
Exposure of hedge funds and gurus
Based on the SEC 13F filings data, about 20 hedge funds have an exposure to Check Point Software, with some key names such as Carlson Capital (managed by Clint Carlson) and Tudor Investment Corp (managed by Paul Tudor Jones (Trades, Portfolio)) increasing their holdings in the company by 14% and 29%, respectively. The largest Guru shareholder in Check Point include Arrowstreet Capital (which holds almost 1.24 million shares in the company). Ken Fisher (Trades, Portfolio) has also been consistently adding the stock to his portfolio through Fisher Asset Management.
Key takeaways
Fundamentally strong companies with high margins and good oulooks have only one problem – they often tend to be overvalued, which may cause investors to buy them at the wrong time and end up losing money. This could be an inherent fear in the minds of investors with respect to Check Point. However, a price-earnings of 21.12 is certainly not too high for a company as financially strong as Check Point that is also providing a strong yield through its buybacks. The stock is trading more than 10% below its 52-week low and looks to have a strong upside. Overall, I believe it deserves a place on the investor watch list as a high-potential, long-term growth investment.
Disclosure: No positions.
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