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Take Advantage of This Company’s Transition Period and Get it on the Cheap

This week’s hot stock is a veteran company in a sector known for its high corporate turnover. Although this company is not nearly as flashy as competitors such as Salesforce.com (CRM) or even Microsoft (MSFT), it has been providing software and solutions to businesses since 1976. This company specializes in IT management software to help manage mainframe, cloud, and mobile environments. These software products and solution services will be in demand well into the future, ensuring that this company’s market will remain stable at the very least. At its current price, this company is attractive even if it fails to grow and makes our Most Attractive stocks list for March. This week’s Hot Stock is CA Inc. (CA).

CA has a long history of growing profits at a slow but steady rate. Since 2004, CA has grown after-tax operating profits (NOPAT) by 15% compounded annually. While CA’s fiscal 2014 results may not look impressive, with NOPAT coming in 1% lower than in 2013, on a trailing 12-month (TTM) basis CA has actually grown NOPAT by 12% over the previous period. CA has also earned a solid return on invested capital (ROIC) of 13% for the past three years.

CA has come under scrutiny by investors over the past few years as its revenues have fallen each year since 2012. This is simply a product of the company shifting towards higher margin businesses while it becomes a leaner organization. Investors can see this fact on display in CA’s growing profit margins and growing free cash flow (FCF), which topped $1.5 billion on a TTM basis.

We like to think of CA as a smaller Oracle — just without the constant market attention to the company’s every move. The good news is that investors can pick up this mini-Oracle at a discount. At its current price of $31/share, CA has a price to economic book value (PEBV) ratio of 0.9, which implies that the company’s profits will permanently decline by 10%. These implied expectations fly in the face of CA’s actual profit growth and of the growing market for its products. Even if CA fails to grow, it is undervalued — but if the company can grow profits by just 3% compounded annually for the next 11 years, shares are worth $39, which represents a 26% upside. These growth expectations seem low when considering CA’s focus markets are projected to grow by 9-13% compounded annually.

With limited downside at the company’s current prices, this one looks like a no-brainer.

Disclosure: David Trainer and André Rouillard receive no compensation to write about any specific stock, sector, or theme.

 

 

About The Author

Andre Rouillard

Investment Analyst at New Constructs

1 Comment

  • John

    March 17, 2015

    Company probably has trouble shaking stigma of past egregious behavior of key executives (excessive stock option compensation, insider trading and illegally pulling revenue forward) that ended up decimating shareholders. Made sweeping management changes starting about a decade ago…continues to purge its previous acquisition binges and has brought down debt to a targeted range. Transitioned itself into a slow and steady supplier of solutions to new markets, as well as a continued supplier to legacy systems. Certainly a far cry from the executive piggy bank, casino circus and fraud-hole it was 15-20 years ago. Amazing to see how a company can recover operationally when its management is wrested from the “good-fellas” and placed in adult supervision. Thanks for the review.

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