2023-09-25 20:51:30 ET
Summary
- Amdocs, a technology company, is a safer investment option with lower volatility than the overall market.
- The company has shown strong financial performance, with consistent revenue growth and a healthy balance sheet.
- Amdocs has outperformed the technology sector in the previous bear market, indicating its resilience and potential for future success.
- The setup for its outperformance in the previous bear market and its current setup look the same.
- I rate this stock as a Strong Buy in the current market conditions.
I have been playing the stock market quite defensively for the last two years. Ever since inflation reared its head and the Fed started swinging aggressively, I have been steering away from growth names (unless they met my criteria) and mostly approaching stocks that would react with lesser volatility than the overall market. This has caused me to miss some of the biggest returns as I stay away from higher beta stocks that are typically more crowded and I have been trying to find value in lesser-known names. No FOMO here though as I believe one of the primary goals in investing should be to reduce drawdown on one's portfolio.
But a low beta stock cannot be the only criteria for an investment and in my search for a high-quality low beta name, I came across this gem of a technology company whose recent performance and price behavior made me comfortable to get behind this company as an investment. I believe in the current environment, investing in this company makes sense for the following reasons -
1. The stock has exhibited lower volatility than the SP500 in the last five years and it looks like a safer investment under current market conditions
2. The company is fundamentally strong with projected growth of close to 8%
3. The balance sheet is healthy and it has been able to grow without relying on debt
4. The company pays a reliable dividend which boosts the overall returns.
5. Its performance in the technology bear market of 2022 has me confident that this stock will outperform should conditions change again for technology stocks.
The Business
Amdocs ( DOX ) is a global leader in providing software and services to the communications, media, and entertainment industries. Their business focuses on delivering comprehensive solutions that empower service providers to enhance customer experiences, manage billing and revenue effectively, transition to digital business models, optimize network services, and streamline operations. Amdocs also offers managed services, consulting, and professional services to support their clients in deploying and maintaining their technology solutions. With a diverse customer base spanning telecommunications, media, and entertainment sectors, Amdocs plays a pivotal role in helping organizations adapt to the challenges and opportunities of a rapidly evolving industry landscape, including the emergence of technologies like 5G and IoT.
Reliable Past and Great future
The company has grown its revenues by more than 10%, EPS by almost 28% in the last three years, and FCF has remained consistently between $350M - $600M with 2021 showing the highest levels of FCF. 2022 was its best year in terms of revenues coming at $4.5B and recent quarters have also brought the company good news with QoQ revenue growth clocking in between 6.5 - 7%. All of its earnings metrics indicate that the company is in a great place currently.
Return on Assets | 8.7% |
Return on Equity | 15.95% |
Return on Invested Capital | 13.37% |
The company has also been making good use of its cash flows by buying back stock, has reduced its share count by approximately 10% in the last three years, and authorized another share repurchase program worth $1.1B. It has also been paying a reliable dividend (2% yield) and the dividends are well covered by earnings and cash flows (35%). All of this comes with a strong and healthy balance sheet. Its cash and short-term investments at $750M completely cover its total debt and it sports a low debt-to-equity ratio (0.17)
Looking ahead, the company believes that it is on track to deliver double-digit total shareholder returns for the third year.
The best part is revenue for the full year is expected to have positive growth again closer to 8% with an expected FCF of $700M and expects to return a vast majority of this to shareholders. It also has a 12-month backlog of $4.14B which is a leading indicator where 80% of the backlog covers 80% of forward 12-month revenue.
Defensive Bet
The stock has a 24-month Beta of 0.6 and a 5Y beta of 0.66 both of which indicate its lower volatility profile than the overall stock market (On average the stock would tend to move 60% as much as the market). The market looks to be on shaky ground and this could prove to be a defensive investment as it is less susceptible to market downturns providing stability and lower risk for a conservative investor. Stocks with low betas can also be valuable for diversification. If you already have a portfolio of higher beta stocks, adding stocks with lower betas can help balance overall portfolio risk.
Even when we look at the overall technology sector, the stock's divergence in performance can be stunning and we can verify this by comparing the returns against the Nasdaq index ( QQQ )
In a bear market year for the Nasdaq (2022), QQQ declined by 32% while Amdocs returned 23%. I understand the pitfalls of comparing past returns and expecting the same for the future but this serves as a demonstration of the stock's resilience. I can count four reasons for this outperformance -
1. The stock's major clients are in the telecommunications industry, an industry that is inherently resilient. Its contracts are long-term and provide a recurring revenue stream with a significant portion coming from support, maintenance, and managed services. Its solutions are deeply integrated into its customers' operations providing its moat through high switching costs.
Amdocs Clients (Annual Report 2022)
2. Its dividends are quite high in the technology sector and are well above the sector's median of 1.7%
3. As we saw already, its buyback program was generous and share repurchases can provide price support for a stock. Buyback programs signal confidence in its own stock, which can help prevent sharp declines in share price during market downturns. This can provide a level of stability to the stock's returns.
4. Its valuations have been quite grounded when compared to the technology sector. In early 2021, the PE ratio for the sector climbed above 30x and Amdocs looked relatively cheap. Its low relative valuation could mean that it also provided less downside especially when its metrics were not only stable but also growing.
Going forward we are not expecting any of these to change even now as the technology sector again looks to be on shaky grounds (QQQ is off by more than 5% from this month's high). The company's business model remains unchanged, we saw that it also has a huge order backlog, expects to have an FCF yield of 7%, and expects to return most of this to shareholders. It also authorized a new buyback program and no negative changes are expected to its dividend. Its current valuation again looks cheap when compared to the technology sector (18.3x Versus 29x). We also saw that its sales are expected to increase meaning lower forward sales ratios (Fwd PS of ? 2x)
The setup now looks the same or even better so it's more than likely to repeat that outperformance (if initial absolute price performance for this month is an indicator; -0.9% for Amdocs versus -1.51% for QQQ)
In the present market conditions, I rate this stock as a strong buy and expect it to exhibit the characteristics I have described in the near timeframe.
What is the downside of this investment?
What we have discussed so far can be a double-edged sword in terms of returns. During the good years for Nasdaq or SPY, this stock can end up underperforming thereby decreasing the returns for your portfolio. Consider that for the last year while QQQ returned close to 31%, Amdocs returned only 10%. The stock's slow-moving nature means underperformance in the good years so an investor should have clarity in terms of this stock's role in a portfolio (and this is what we tried to cover in our write-up).
For further details see:
Amdocs: A Low Beta Stock Your Portfolio Is Asking For