How Much Is FactSet Research Systems Worth?

FactSet Research Systems (FDS, Financial) aggregates and distributes financial information and analytical systems to investors, portfolio managers, research and performance analysts, risk managers, marketing professionals, sell-side equity research professionals, investment bankers and fixed income professionals who are active in the investment community.

FactSet Research Systems generates and distills content on companies operating in markets from all over the world and aggregates it into a single online platform to facilitate analysis. This includes real-time news and stock quotes and tools to value and analyze fixed income securities and derivative portfolios.

The company consolidates content from hundreds of sources and makes available various analytical systems to support and facilitate the investment decision-making process. It provides published research content from various professional buy- and sell-side analysts. Its analytic tools facilitate company analysis, company comparisons, industry analysis, company screening and portfolio analysis. It also facilitates predictive risk analysis, portfolio optimization and Monte Carlo simulation.

The company operates through three geographical business segments: U.S., Europe and Asia Pacific. The U.S. segment serves finance professionals including financial institutions throughout America. The European and Asia Pacific segments serve investment professionals located throughout Europe and Asia.

Determining how much FactSet is worth

When assessing the competitive strength and investment merit of any firm, the first thing we like to do is to look at what’s going on with sales – that’s really the first level of inquiry that any investor should undertake. Ideally, we are looking to invest in companies whose sales are strong, consistent and generally growing faster than nominal GDP growth (that is, real GDP growth and inflation combined).

Based on FactSet Research Systems’ historical sales data, things look pretty steady. The 10-year sales growth has been 11% a year. This compares to nominal GDP growth of 3% per year over the same period, which is perfectly acceptable for a firm of its size. Starting in 2010, FactSet Research Systems' sales pulled back a bit due to intensified competition and industrywide price cutting, but since 2011 it appears to have been on solid footing.

All that said, we feel comfortable saying you can invest in this company if you're looking for steady growth. FactSet Research Systems' sales growth has been 9% per year over the last five years and 10% per year over the last three years. FactSet Research Systems' three-year revenue growth is actually ranked higher than 75% of the 608 companies in the Global Business Services industry.

Overall, we can see that FactSet Research Systems has an attractive revenue profile and has done a superb job of generating strong, stable and growing revenue. We expect good things from this company in the future.

Figure 1: Revenue ($ millions) and revenue growth (%)

The second thing we like to do when assessing sales is to look at consensus market estimates. As reported in Yahoo Finance, the market is projecting 6% annual growth for this year and 8% for next year. These estimates are drawn from the projections of 18 analysts. The sales estimate is 1.18 billion for 2017, which compares to the year-ago estimate of 1.13 billion. Note that the company does not provide any revenue guidance.

A third thing we like to do when assessing sales is to compute the firm's sustainable growth rate. The sustainable growth rate reflects the rate of growth in sales that a firm can support given its existing earnings power, capital resources and dividend payout policy. In any given year, a firm's sustainable growth rate is calculated by multiplying its return on equity (ROE) by its retention rate. Rather than rely on data from only one year, however, we calculate sustainable growth by using the firm's three-year average ROE and three-year average retention rate. FactSet Research Systems' ROE averaged 50% over the last three years while its retention rate averaged 73%, giving the firm a sustainable growth rate of 37% per year.

Let's recap briefly what the sales data is showing us. From what we can tell, it is not unreasonable to estimate that sales over the next five years could grow at a rate of somewhere between 0% and 37%.

Table 1: Choices for possible growth rates

We're going to select a rate of 5%. With $1.127 billion in sales generated last year, this means we believe that sales will continue to grow in the future and will reach about $1.439 billion in five years. This estimate reflects our understanding of the firm's historical results, the intensity of competition within the industry, changes in buyer preferences and new product/service launches.

Estimating earnings per share

Now that we have generated our sales estimates, we’re going to estimate growth in earnings per share. This method applied below takes the sales growth projection – in this case, 5% per year – and subtracts the expenses and taxes. What we're left with are the earnings. Then we divide by the projected number of diluted shares outstanding to determine the earnings per share (see table below).

A projected growth rate of 5% will result in almost $1.439 billion in sales five years out. Now we need to take a look at the firm's pretax profit margin (what’s left over after expenses but before taxes are subtracted). In Figure 2 below, we can see that FactSet Research Systems has been doing a decent job maintaining its profit margin – 32% in 2013, 33% in both 2014 and 2015 and 41% in 2016. The average for the last five years has been 35% and the average for the last 10 years has been 34%.

We believe that FactSet Research Systems' margins will revert to its near term mean of 35%. At this rate, projected pretax profits on $1.439 billion in sales would be just over $504 million. This means expenses would amount to $935 million.

Figure 2: Pretax profit margins (%)

The next step in our estimation process is to establish which tax rate will be paid on the company's profits.

The most recent year’s rate was 27%. Normally we wouldn't play with that number too significantly because in general, it shouldn't change much from year to year. The only time we would make major changes to this number would be in instances where maybe the current rate differed significantly from that of the past or if we had some knowledge about which rate was likely going to persist in the future, perhaps because the company is going to get some preferential tax treatment on operations abroad.

For FactSet Research Systems over the last 10 years, the company's tax rate has been as low as 27% and as high as 34%. Tax rates for most U.S. companies will fluctuate between 35% and 40%. We're going to select a rate of 30%, representing the average rate of the last 10 years, excluding the influence of nonrepresentative years. This would result in a tax expense of $151 million from pretax profits of $504 million in five years. This would leave us with $353 million in projected earnings five years from now.

Our next main consideration is a matter of determining the number diluted shares that will be outstanding in five years. FactSet Research Systems has significantly decreased the number of shares outstanding over the last decade. There were 49 million shares outstanding in 2007, then the number of shares went down to 47 million in 2011 and 41 million in 2016. Currently there is 41 million shares outstanding. This data suggests that the company has been repurchasing about 1 million shares per year. We're going to rely on the company's historical share repurchase activities to guide our estimation process but will be far more conservative as we think the company will seek more aggressive uses of its cash to revitalize growth. As such, we project share repurchases of 1 million per year over the next five years.

With shares estimated at 37 million in five years, EPS is expected to grow at a compound rate of 3% over the period. This is slightly higher than our projected five-year revenue growth rate. Note that it doesn't always work out this way. Based on this EPS growth forecast, we are expecting EPS of $9.61 five years out. Results of our forecasting procedure are summarized in the table below.

Table 2: Path from projected sales to projected earnings

Forecasting a target P/E multiple

Now we need to take a look at the price history of the company's stock. From Figure 3, we can see that the spread between the high and low stock prices has widened over the last five years. We have a current price of $159.01, with a high in the past 10 years of $179 and a low of about $33. We want to keep this growing variability in mind when establishing our upper and lower valuation range. Specifically, given the firm's historical stock price behavior, we should expect the stock to fluctuate by at least $29.23 over the course of a year.

Figure 3: Stock price history: close, high, low

FactSet Research Systems' stock has traded at fairly consistent price-earnings (P/E) multiples over the last decade (excluding 1999 and 2000 during the tech bubble), averaging 24 over the last 10 years, 24 over the last five years, and 25 over the last three years. Currently the firm is trading at 19 times trailing 12-month earnings per share and 22 times expected future earnings.

For determining an estimated target P/E multiple, the first thing we like to do is eliminate any outliers from the historical data series. This includes abnormal P/Es that are not reflective of the normal operations of the firm, and this could be the result of abnormal growth or significant one-time nonrecurring charges/gains. In the case of FactSet Research Systems, we are going to leave the historical series intact. The next thing we like to do is to run an optimization procedure that reveals which P/E multiple yielded the best forecasting accuracy over the evaluation period. If in our judgment this multiple continues to accurately portray the earnings and cash-generating power of the company as well as the growth and risk characteristics of the firm, then we will use this multiple as our target multiple. If not, we will adjust the multiple upward or downward accordingly.

The figure below presents the historical P/E profile for FactSet Research Systems. We will utilize a target P/E multiple of 21x which we believe reasonably characterizes the risk-return attributes of the company's stock. This multiple represents an expansion of 6% relative to the current multiple. It also represents a contraction of 30%, 25% and 24% relative to the three-year, five-year and 10-year average P/E multiples.

Figure 4: Historical P/E multiple and target point of reversion

Setting a target price and valuation range

We selected a target P/E multiple of 21x. To determine a price target five years out, we then multiply this by our EPS estimate. EPS are estimated to reach $9.61 in five years giving us a target price of $197.08. Now, this price is significantly higher than the current price. It’s also higher than the price at which it has traded historically. Nonetheless, to properly judge to what extent the stock may be under or overvalued, we need to determine a fair-value range within which we expect the stock to trade.

To do this we rely on the trend-adjusted average annual trading range for the stock, which from the analysis above we know is $29.23. This means that, given our target price estimate, we expect the stock to trade naturally, and fairly, between $182.47 and $211.70. The result of this is that when the stock is trading below $182.47 it is in the Buy Zone and when the stock trades above $211.70 it is in the Sell Zone.

Conclusion

So what return can we expect for holding FactSet Research Systems' stock? Well, we now know we can expect stock price appreciation of 24%. We can also expect to earn dividend income of about $9.40 over the evaluation period. Added to our price estimate, this means we could earn a compound annual rate of return of 5%, provided our estimates prove accurate.

This company offers acceptable return potential to take a position in the stock. Don't expect enormous returns; purchase FactSet Research Systems for its steady and stable operations and cash-flow stream.

Disclosure: We do not currently hold any positions in FactSet Research Systems.

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