In his second-quarter 2022 letter to investors, Ron Baron (Trades, Portfolio) of Baron Funds noted some investors had lost faith in Gartner Inc. (IT, Financial). He said they were concerned about the effects a potential recession could have on the company. That concern affected Baron’s funds.
Yet, the guru is not giving up on the company, as he commented the following in his letter:
“We remain invested. Business conditions are strong, with Gartner’s research business compounding at double-digit levels. We expect sustained revenue growth and renewed focus on cost control to drive margin expansion and enhanced free cash flow generation. The company’s balance sheet is in excellent shape and can support repurchases and bolt-on acquisitions.”
Is his faith in Gartner truly deserved, or are we looking at the end of the information provider's growth streak?
Based in Stamford, Connecticut, Gartner specializes in researching and analyzing information for the information technology industry and related fields.
In its 10-K for 2021, the company says it “delivers actionable, objective insight to executives and their teams. Our expert guidance and tools enable faster, smarter decisions and stronger performance on an organization’s mission-critical priorities... Organizations are overrun with data and information. Gartner helps eliminate this information chaos and provides clarity with actionable, objective insight.”
The company serves more than 15,000 enterprises in some 100 countries. It operates through three business segments: Research, Conferences and Consulting.
Gartner reports it faces competition from a wide variety of sources, from other consulting firms to free information on the internet. As it observed, it operates in markets with low barriers to entry.
Several competitive advantages are cited in the 10-K, including:
- Superior research content
- Leading brand name
- Global footprint and established customer base
- Experienced management team
- A vast network of experts and consultants.
One other competitive advantage which deserves further emphasis is the operating leverage found in its business model. Once created, intellectual property and expertise can be distributed across multiple platforms, including programs, conferences and consulting engagements.
Below is Gartner's historical share price chart. As we can see, growth was slow but steady until the Covid pandemic hit, which was when the stock really skyrocketed. Now its price-earnings ratio is in the 30s, which is a bit high but lower than its historical median of 41.
Here are its annualized returns for selected time periods:
- One year: 0.07%
- Three years: 32.12%
- Five years: 18.38%
- 10 years: 20.20%.
The company gets a GuruFocus financial strength rating of 5 out of 10:
The first four lines on the table suggest the company has a heavy debt load, and that’s confirmed by this chart of cash and debt:
Nevertheless, the Piotroski F-Score of 8 out of 9 suggests the company is doing a good job of managing its finances. The Altman Z-Score indicates Gartner is at no risk of bankruptcy.
Its return on invested capital (ROIC) of 11.28% slightly exceeds its weighted average cost of capital (WACC) of 10.08%, so value creation is present but not significant.
Gartner scores much better on profitability with a rating of 10 out of 10:
One of those green bars should be scratched from your considerations, and that’s the return on equity. Why? Because the equity portion of the ROE is negative. Gartner’s total liabilities are greater than its total assets. According to the balance sheet at the end of June, the company’s total assets were $6.591 billion and total liabilities were $6.733 billion. That leaves total stockholder equity in a negative position and corrupts the return on equity calculation.
Gartner increased its revenue by an average of 8.4% per year over the past three years. At the same time, it grew its earnings per share without non-recurrint items by an average of 90.6% per year.
The growth of free cash flow also looks attractive. Looking at a 10-year chart shows it shot up in the last couple of years, but has still enjoyed respectable growth over the past decade:
Dividends and share buybacks
Gartner does not pay a dividend, but it has given shareholders a boost by repurchasing shares over the past decade:
The GF Value chart arrives at a significantly overvalued rating for Gartner:
Still, its price-earnings ratio is in line with other companies in the software industry, and thanks to its rapidly growing Ebitda, it has a PEG ratio in the fair valuation area.
Using the default settings on the GuruFocus discounted cash flow calculator, we would be using an EPS without NRI growth rate of 7.2% per year, which is what the company has achieved over the past decade. However, over the past five years, the growth rate averaged 79.5% per year, and just last year the growth was 36.70%.
The default of 7.2% per year indicates a fair value of $139.56 for the stock, which is less than half the closing value of $295.44 on Aug. 5. But if we extrapolate a future 10-year growth rate of 20% per year, which seems more reasonable in my opinion, we get modest undervaluation:
Looking at a 10-year price chart suggests Gartner shares may be modestly overvalued based on the trendline:
Nine gurus hold positions in Gartner, including:
- Ron Baron (Trades, Portfolio) of Baron Funds, who reduced his holding by 1.17% in the first quarter, leaving him with 5,274,931 shares on March 31. Those shares represented 6.55% of Gartner’s outstanding shares and 3.85% of Baron Funds’ holdings.
- Al Gore (Trades, Portfolio) of Generation Investment Management held 2,199,745 shares, a reduction of 0.34%.
- Bill Nygren (Trades, Portfolio) of the Oakmark Fund also cut his holding by 2.09% and finished the first quarter with 1,176,524 shares.
Most of Gartner’s shares (97.76%) are in the hands of institutional investors.
While Gartner has a heavy debt load, which may be enough to discourage value investors, it remains a powerful company on the growth front. Personally, I believe it has the capacity to keep growing at a rapid pace and maybe even beat the S&P 500 for the next five to 10 years. I agree with Ron Baron (Trades, Portfolio) on this one.