Value Wins In The End

When I was building my position in CA Technologies I overwhelmingly heard bad things about the company from analysts and investors. These were the most common criticisms:

  • They are a slow growth company. There are so many companies out there with better growth.

  • The stock has gone nowhere in a decade.

  • The management team is not the best (to put it lightly)

  • Management will squander the money

  • A highly paid hedge fund consultant said CA is where good technology goes to die.


When I looked at CA I saw a company that was trading at less than seven times free cash flow (FCF/EV) or a greater than 14% cash yield. If the company is able to consistently generate so much cash despite the fact that they don't have good management than the underlying business must be really great. Where a stock has traded in the past decade matters little to me. If we were able to simply extrapolate the past into the future we would all be rich. Management had already committed to return 40%-50% of free cash flow to investors so at most they could squander half the money. A 7% cash return was still not bad.

The mistake most made in their analysis of CA is that they completely ignored valuation. There is no price at which they would have liked this stock. I would love it if CA grew like Salesforce.com but the free cash flow yield on Salesforce.com is a fraction of CA's. Salesforce.com would need to increase their free cash flow many times over before they yielded as much as CA. I prefer a bird in the hand.

I have been holding CA for over a half a year, all the while hearing about what a terrible stock it was. It was not  a pleasant experience but as a value investor and a contrarian I am used to it. After earnings last night CA broke out to a multi year high. CA has solidly outperformed nearly every large cap software stock during the period I have owned it and the market as a whole. Value wins out in the long run and for CA the long run has finally arrived.

 

15 comments:

Baconus Maximus said...

I would have much rather owned IBM over the same span of time. Up 23% over the last year vs CA which is down nearly 10. CA doesn't do well because its products are not well regarded in technology circles.

Tsachy Mishal said...

CA is trading at a multi year high, up 16% in the pre-market.  Luckily, I did not
buy CA a year ago. In the past 6 months CA has handily outperformed IBM. As I
wrote in my post I believe that ignoring valuation is a mistake as is
extrapolating the past into the future. At some price CA is undervalued
and at some price IBM is overvalued. Your analysis does not consider
that.

Tsachy Mishal said...

I believe IBM is overvalued and would much rather own ORCL, BMC or CA. I am actually considering shorting IBM against my software longs.

Chris Lau said...

Can the same be said of RIM (in regards to valuation)? Key metric is FCF. CA's FCF is strong but RIM's a "transition" story so the FCF is poor, inventory built up on one product alone (playbook) + a drop in bb7 sales.

Tsachy Mishal said...

Part of my assumption was that the cash flow is steady at CA. 75% of CA's business is renewal and the average contract length is over 3 years. RIMM's FCF is highly unpredictable.

Tsachy Mishal said...

Part of my assumption was that the cash flow is steady at CA. 75% of
CA's business is renewal and the average contract length is over 3
years. RIMM's FCF is highly unpredictable.

RIMM might work out fabulously if they can turn it around or might not. Im too chicken to be involved in such a situation either way.

Onlooker from Troy said...

Nice analysis and way to stick to your informed conviction.

Onlooker from Troy said...

Wow, Rydex traders really flipped bullish yesterday.  That was quite a shift, especially coming after the large shift to bearish just before.

Tsachy Mishal said...

Great catch. I missed that

Shubh Desai said...

Hey Tsachy,
What do u think about EXC? I think its a good value, do you agree?

Tim Gilbert said...

So what is the play on CA now...unload it or is it going higher?

Tsachy Mishal said...

I'm holding on. Hoping to get closer to $30

Tsachy Mishal said...

EXC is a utility that largely generates through nuclear. Electricity gets priced off of natural gas. When natural gas is high EXC makes a bundle. Right now natural gas is in the dumps and EXC is suffering. Due to fracking and the abundance of natural gas it's hard to see times getting great for EXC in the near future. But you get paid a decent dividend to wait.

Jaclyn Mishal said...

Congrats!

Tsachy Mishal said...

Thanks Jaclyn. Aaron says hi

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