Value.able: Six new stocks

PORTFOLIO POINT: Here’s a group of companies that enjoy a high level of recurring revenue – invaluable in these difficult days.

With many of our key market indices down 20% already this calendar year and daily volatility frequently exceeding 2%, it may seem that there is little if anything that could be classified as stable in our current sharemarket.

But that is only be true if you choose to take your cue from prices. This week I would like to take the opportunity to show you six companies that have demonstrated stability in one of the key characteristics you should look for: intrinsic value growth.

If your heart skips a beat when the lead story on the morning radio is whatever has caused conniptions in the markets overnight, you need to remember that daily market “prices” are just that.

There will be another price tomorrow and it will be different from today’s. Prices are only relevant when compared with value. Let panic sellers or fund managers do what they will and be influenced by prices at your own expense.

The best advice I can give you is to keep calm and carry on.

There is stability in the current environment if you know what to look for. Focus on the business. Buy those with bright prospects for intrinsic value appreciation. Share price appreciation will follow. I am convinced that a consistent approach to acquiring, at rational prices, the shares of quality companies will reward the patient investor. In five, 10 or even 20 years the current worries will have passed. Prices today or next week are only relevant if you need to transact immediately.

In market conditions such as those we are currently experiencing, prices over the short run will inevitably detach from the value of even the most stable underlying businesses they are attempting to take the meter of. Rest assured that price follows value over the long term.

The accompanying illustrations are of company share prices and their valuations for up to 10 years.

Notice how stable their share prices appear when modelled against their intrinsic worth over time? It is in this context that one can see the wood for the trees, the diamonds in the rough or the lighthouse in the tempest. These are stable underlying businesses generating equally stable improvements in intrinsic value (dotted line) even though their share price is anything but stable in the short term.

The desirable common trait shown by all of these businesses is rising intrinsic values. So the next question is: What might be driving such a desirable outcome?

Yes, all the companies shown here enjoy high rates of return on equity, they all have manageable, little or no debt and they all enjoy the benefits of low levels of capital intensity, helping to generate copious cash. But what really marks them as a little special is the significant levels of recurring revenue.

For example, Iress (ASX:IRE, MQR:A1), enjoys close to 80% recurring revenue through the supply of its information and trading platforms; Hansen (ASX:HSN, MQR:A1) close to 70% through the supply of billing platforms and software; Reckon (ASX:RKN, MQR:A1) close 60% through its provision of online accounting, personal finance and practice management software; and M2 Telecommunications (ASX:MTU,MQR:A1) close to 67% through telecommunications and internet access plans.

The benefits of recurring revenue cannot be overstated, especially during periods such as we are experiencing now. Few listed businesses begin each financial period with a material amount of their revenue locked in for the year ahead. It is these recurring revenue streams that contribute to positive cash flows, which in turn help derisk a company through strengthening balance sheets. The solid financial position then enables a business to comfortably expand current operations and take maximum advantage of other opportunities as they arise.

A portfolio constructed from such business purchased at discounts to intrinsic value, should easily outperform the index. And it’s on that basis that I am going to create a second Value.able portfolio today called the Recurring Value.able portfolio. It will sit within the Value.able portfolio and its purpose is simply to demonstrate to you the relative performance of these five holdings compared to the market. The only twist is that I will overweight the stocks that are trading at the largest discounts to my estimate of intrinsic value.

I don’t believe the level of recurring revenue will change materially if Greece defaults and even if equity risk premiums increase because of more frequent recessions in the US, forcing price to remain depressed even in the face of rising earnings, these holdings should perform as true defensives. Let’s add them to the Value.able portfolio today and come what may, track their relative aggregate performance. Stay tuned.

Roger Montgomery is an analyst at Montgomery Investment Management and author of Value.able, available exclusively at rogermontgomery.com.