With all the talk of hacking recently, one might expect companies like Check Point Software Technologies (CHKP, Financial) to be posting new highs. But neither Check Point nor its peers in cybersecurity have done so lately. What’s up?
Check Point pops up when we run a screen designed to find great companies at great prices. More specifically, the Macpherson model uses four criteria to identify what may be great companies, subject to due diligence:
- No debt.
- Return on assets: a median value of at least 15% per year, averaged over the past 10 years.
- Return on equity: a median of at least 15% per year over 10 years.
- Return on capital: again, a median of at least 15% over 10 years.
What are the results?
- Check Point has no debt
- Its median ROA over the past 10 years is 13.63%; this metric made it through the screener with an ROA of 15.04% in 2017.
- The median ROE over the past decade is 18.78%, and its 2017 number is 22.65%.
- Median ROC since 2008 is 29.03%, and its 2017 level is 34.61%.
The company meets three of these criteria and comes close on a fourth. So, subject to due diligence, Check Point could be considered a great company.
But is it available at a great price? That’s determined by its intrinsic value. Value investors will look for many discounts to intrinsic value, so there is no one right price. Still, discounted cash flow results will provide basic numbers.
DCF comes in two main forms: based on free cash flow and based on earnings. On March 23, Check Point's DCF-free cash flow was 0.87, or below intrinsic value. On the other hand, its earnings-based DCF was 1.08, or above intrinsic value. Average the two together and you get an intrinsic value roughly equal to the current share price.
To put that information in context, here is a five-year price chart:
In an InvestorPlace article about Palo Alto Networks (PANW, Financial) published on March 18, James Brumley said Palo Alto's upward progress had slowed because its shares have been overbought. He continued:
“For the record, Palo Alto Networks rivals FireEye Inc (FEYE, Financial) and Check Point Software Technologies are more or less in the same boat. CHKP stock isn’t quite so overbought but along with FEYE stock, they are also both hinting at a lull (particularly in the wake of FireEye’s recent surge). This trading outlook for Palo Alto may be almost as much about group-wide weakness as it is the company itself.”
At MarketWatch, Wallace Witkowski wrote on Nov. 2: “Cybersecurity stocks that went on a tear following the Equifax Inc. (EFX, Financial) hack are falling back to earth after quarterly results did little to sustain enthusiasm for the surge.”
He also wrote that Check Point shares had just dropped 12% after its revenue outlook came in below Wall Street expectations.
At Chaffey Breeze, they reported on Feb. 2 that Check Point had gapped down again because Wells Fargo & Co. (WFC, Financial) downgraded it from outperform to market perform. Other analysts, it says, haven't had the same enthusiasm they had for it in the immediate wake of the Equifax breach.
Among analysts followed by NASDAQ.com, the consensus recommendation is a hold, although almost as many offer strong buy recommendations:
Among the gurus followed by GuruFocus, three have significant holdings in Check Point: Pioneer Investments (Trades, Portfolio), Ken Fisher (Trades, Portfolio) and Caxton Associates (Trades, Portfolio).
In guru trading during the fourth quarter of 2017, Jim Simons (Trades, Portfolio) and Ron Baron (Trades, Portfolio) reduced holdings to nearly zero. Jeremy Grantham (Trades, Portfolio) and Chuck Royce (Trades, Portfolio) sold out, while Caxton, Fisher and Pioneer added shares.
While this information helps us understand the stock’s recent price activity, it also restricts us to a short-term perspective.
Looking to a longer-term of up to five years, we go back to the original premise: The world is awash in malicious hacking. Whether at the personal, corporate or government level, there is ongoing pressure to buy new and better software as the hackers continually upgrade their cybercrime tools.
Essentially, its future boils down to the strength of its moat to keep it in the game and allow it to protect its pricing. Let’s look in more detail at the metrics behind its moat:
- Return on capital more than meets the median 10-year average of 15%; the lowest level in the past decade was 26.24% and its highest (in 2017) was 34.61%.
- Return on tangible equity is the second criterion for a competitive moat. For his screens (Macpherson model), Thomas Macpherson wants a median ROTE of at least 15% over the preceding 10 years. That's easily achieved by Check Point: the lowest ROTE over the past 10 years was 22.93% and its highest was 29.59%.
Both criteria, then, are well above the 15% mark, indicating the moat is strong. This chart of ROC, since inception more than 20 years ago, shows return on capital has consistently stayed between the mid-20% and mid-30% range for the past decade:
Note the spectacular results in the late 1990s and early 2000s overshadow its steady but excellent returns since 2008.
Conclusion
Check Point Software is a great company based on the criteria of the Macpherson model. In particular, it has a strong moat based on its ROC and ROTE measures.
Barring catastrophe, that moat should protect the company for the next five years. Disruptive new technologies may roil the industry, but with its industry-leading position, Check Point is as likely to bring in the disrupter as to be among the disrupted.
The secular trends that have driven this industry will no doubt continue. Cyber theft and cyber destruction show no signs of waning; instead, we are routinely warned of new threats as malware grows increasingly sophisticated. Just today I learned of FakeBank, new malware that redirects phone calls to banks to scammers. At the moment, it appears to affect only Android devices (before OS 8) and mainly South Korean banks, but I would not be prepared to bet on it not spreading.
With the current share price close to intrinsic value, it should not be considered a great price. It has no margin of safety and, if history is a guide, the current dip is about as much of a price break as we can reasonably expect. Check Point’s price has dipped and this may be a time to buy, subject to further due diligence.
Disclosure: I do not own shares in any company named, and do not expect to buy any in the next 72 hours.
