The perfect tech stock for value investors

CA isn't as buzzworthy as Facebook or Twitter, but its core portfolio is absolutely vital to its customers' infrastructure.

By StreetAuthority Jun 17, 2014 4:56PM

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By StreetAuthority, Adam Fischbaum

As you might deduce from reading my work here at StreetAuthority, I'm a bit of a cheapskate.

For example, I don't buy new cars. I hate the idea of the instant $5,000 depreciation you experience the minute you drive a new car off of the lot.

As a result, I'm more attuned to used-car valuations. Naturally, late-model brands with a history of dependability have higher, more stable resale values -- but the same isn't always true for stocks.

Take tobacco giant Altria Group (MO). Over the past five years, the company's net income has grown at an average annual rate of around 7 percent. Not setting the woods on fire, but very predictable and consistent. Shareholders have been well rewarded: Not including dividends, the stock has returned an average of 47 percent a year over the past five years. Investors are willing to pay up for that consistency.

Going back to my car example: I had a Subaru that I bought used. It was a great car. I could set my watch to it. But what amazed me is how little I paid for it -- and how little I got for it when I sold it. It was a Japanese car, incredibly reliable . . . but it couldn't generate any interest.

Enterprise software maker CA Inc. (CA) is a little like that Subaru: a great, reliable, undervalued investment that no one really knows about.

Originally known as Computer Associates, CA provides information technology (IT) management software. The company's products include software solutions for infrastructure management, IT security, storage management, and application performance management.

While not as buzzworthy as other tech names like Facebook (FB) or Twitter (TWTR), CA's core portfolio is absolutely vital to its customers' tech infrastructure. As a result, this $13 billion company has seen its net earnings grow at a steady rate of around 6 percent over the past five years.

While CA's stock has averaged a 15 percent annual gain over the past five years, apparently, investors are willing to pay more for Altria's consistency. I'll take CA's Subaru-like performance any day.

Slow and steady
Contract renewal rates among CA's large mainframe solutions customers, its largest business segment, run at about 95 percent. That means an amazingly predictable revenue stream.

Granted, 5 year average annual revenue growth is an underwhelming 1 percent. But the flipside is average annual revenue of around $4.5 billion that generates a little more than $1 billion dollars in annual cash flow over the same time period. This has helped CA reduce its overall debt from $2.6 billion five years ago to $1.3 billion in 2013.

That's an incredibly well engineered company that has grown earnings consistently and managed to practice that much fiscal discipline. In time, that will pay off for shareholders.

The company's most recent quarterly earnings report surprised consensus estimates by 5 percent, coming in at 61 cents a share versus the forecast 58 cents a share. Revenue was also slightly higher than expected, coming in at $1.108 billion versus estimates of $1.089 billion. Billings also exceeded expectations coming in at $1.434 billion as opposed to forecasts of $1.365 billion' and upside surprise of 5 percent.

A bondlike stock
In previous articles, I've referenced the Warren Buffett concept of investing in a company whose results are so steady and predictable that its stock almost behaves like a bond. I would much rather own a company that delivers 5 percent to 6 percent year in and year out than a company whose results are all over the place.

CA fits this bondlike description -- but the herd has not recognized this quality. CA trades at a low forward price-to-earnings (P/E) ratio of 11.5.

The dividend statistics are also intriguing. CA's dividend payout ratio is 50 percent (my target maximum is 60 percent). The dividend has grown at an average rate of over 100 percent during the past five years, jumping from $0.16 a share in 2009 to $1 presently, good for a yield of 3.5 percent.

That's extremely impressive, considering enterprise software peers such as Oracle (ORCL) and SAP (SAP) have dividend yield of less than 2 percent.

The company has also been repurchasing its stock. Currently, CA is in the middle of a $500 million buyback program.

Risks to consider: While CA's seemingly steady mid-single-digit growth may seem secure, it could be indicative of a slowing segment. Many companies are migrating from large, proprietary mainframe software systems to cloud-based solutions. While competition is fierce in this sector, CA is investing in cloud solutions by acquiring Nimsoft, a cloud managed services provider, in 2010 for $350 million in cash. Another consideration is the overall sluggish growth of the global economy.

Action to take: CA shares currently trade near $29 with a forward PE of 11.5 and a dividend yield of 3.5 percent. Based on its consistent operating history and business model and stellar dividend growth, a modest expansion of the forward P/E to 16 would result in a 12- to 18-month price target of $40. With the substantial dividend yield, that's a potential total return of over 40 percent.



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