2023-06-29 13:00:00 ET
Summary
- FactSet Research Systems has a high customer retention rate and a subscription-based business model that has seen consistent growth in revenues and operating income over the past 20 years.
- It currently holds a small share of the total addressable market, indicating room for expansion. However, it faces stiff competition from dominant players like Bloomberg and Refinitiv Eikon.
- FactSet currently may be overvalued; my buy price is $320 per share.
FactSet Research Systems ( FDS ) is a financial software and data company used by analysts around the world because of its integrated financial information and analytical applications to investment. It was founded in 1978 and is headquartered in Norwalk, Connecticut.
Overall, it is a company that in my opinion has the characteristics to become one of the best in its field, yet objectively there does not seem to be much interest in it. Just look at how many articles on Seeking Alpha were written on FactSet in 2023: only 3 excluding mine. In short, this company does not arouse much curiosity. But why?
In my opinion, the reason is because it is not the typical cutting-edge tech company involved in AI, but simply a "boring" company growing at a steady pace year after year. In short, it is certainly not the right company for those who plan to get rich in a short time. However, for those who understand that wealth is a process and not an event, I think this company may prove to be a pleasant surprise.
Important general considerations
As previously mentioned, FactSet is a company specializing in financial data and analytics, targeting primarily investment banks, asset managers, asset management companies, and other financial professionals. In short, FactSet Research Systems offers a multiplicity of services to facilitate the work of investment professionals, who through it can make more informed investment decisions. Thanks to the breadth of financial data at its disposal and its reliability, the company has built up an important reputation over the years.
To date , about 180,000 investment professionals use the workstation and about 90% continue to use it year after year. The retention rate is very high because clearly the customers are satisfied with the service. After all, I don't think they would pay an annual subscription of $12,000 for something that is not indispensable.
On this point, I think it is worth focusing on, as the subscription-based business model has made the earnings strength of this company definitely out of the ordinary. It sounds absurd, but for the past 20 years nothing has been able to stop the growth in revenues and operating income.
Every single year there has been an improvement, and neither the great financial crisis nor a global pandemic has affected it much. But the positive aspects regarding FactSet do not end there.
Both Return on Capital and Return on Equity historically have been above 30 percent; furthermore, in the long run the company tends to buy its own shares. In recent years the statistics have changed slightly, but not because FactSet has gotten worse, simply because it has focused on expanding in its market by acquiring useful companies to feed its ecosystem.
After all these acquisitions, especially CUSIP Global Services for $1.92 billion from S&P Global ( SPGI ), the balance sheet got a major boost but this has not yet been reflected in the income statement, which is why Return on Capital has deteriorated a lot in recent years. These investments were not made for immediate returns, but to unlock new synergies and growth drivers over the long term. Either way, even with the acquisitions, FactSet's results remain excellent.
Since these acquisitions required a major economic effort, buyback has not been the priority in recent years, but a few days ago something changed. On June 20 the board of directors approved a new share buyback authorization of up to $300 million .
So it would seem that capital allocation is again following this order, and buyback is again becoming a priority. Finally, to conclude this section, I would like to discuss the dividend yield of this company as I believe it is definitely undervalued.
Currently the dividend yield is only 1 percent, but dividend growth is certainly something to consider.
In 2002 the dividend per share was only $0.12, today $3.65, impressive growth and also sustainable. At this point some might point out that this is an almost utopian consideration, since maintaining for so long a company that 20 years ago was known to few is not for everyone. However, while I find such an argument reasonable, I would like to point out that even buying FactSet 10 years ago would have improved the dividend per share considerably: from $1.32 to $3.65, almost three times as much.
The dividend yield on cost would have been almost 4%, which is absolutely not bad.
In other words, I find it reductive to consider FactSet's dividend unattractive just because the dividend yield is 1%.
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Its year-on-year growth is its strength, and companies in its sector are not keeping pace.
What's more, one does not even have to wait too long to receive a decent dividend yield. Over the past 10 years, the dividend has experienced a CAGR of 11.05%; if this growth continues over the next 10 years, the dividend per share would rise from the current $3.65 to $10.4: an on-cost dividend yield of 2.60% if purchased at the current price.
Often when we talk about dividends we look to the usual consumer staples or REITs; however, I believe that sometimes there are better alternatives and FactSet is proof of that. Don't be misled by high but unsustainable dividend yields, the best dividend yields are built by investing in companies that increase it quickly in a sustainable manner year after year. Wealth is a process and takes time.
Growth opportunities and focus on competitors
Although FactSet has been growing year after year for decades, it is worth noting that at the end of the day we are talking about a company with a market capitalization of about $16 billion: not that big. The room for growth is still there and the opportunities are not lacking.
As we can see from this picture, FactSet generates revenues significantly below the serviceable addressable market, which means it still has room to increase its market share. If we looked at the total addressable market, FactSet has a share of only 5.62 percent. The latter also includes services that the company does not currently offer, but potentially could in the future.
In other words, FactSet has been growing year after year for decades, has high profit margins, and yet its influence in the market in which it operates is still relatively small. But how is this possible? The reason is mainly due to how the financial data providers market is structured. Basically, this market is dominated by two providers, Bloomberg and Refinitiv Eikon, while the third place is fought between FactSet and Capital IQ. Between second and third place, however, there is an abyssal difference.
- Bloomberg has 33.40 percent market share, making it the most widely used terminal in the world among professionals. Its dominance has been unchallenged for decades and to date it is the best provider around. However, there is one problem: the annual subscription varies between $24,000 and $27,000, so it is not for everyone.
- In second place is Refinitiv Eikon with a market share of 19.60%. This provider has similar financial data as Bloomberg, but they do not have the same breadth. Overall, it is a valid, slightly cheaper alternative. In fact, it costs about $22,000 per year in its complex version; $3,600 in its reduced version.
More than half of the market is dominated by these two providers, both of which are very expensive but represent the best you can get. In any case, the world leader remains Bloomberg, especially for bond market data, in fact it is indispensable for all professionals in the debt capital markets. The instant messaging service is another feature that has helped it build its competitive advantage.
- Below the two leaders are Capital IQ and FactSet, with a market share of 6.20 percent and 4.50 percent, respectively. These two providers are similar to each other, particularly in terms of their target customers, mainly professionals in investment banking. However, there are also important differences: FactSet is more suitable for those who need real-time data and a simple and intuitive platform; Capital IQ is superior in equity research.
Either way, I think the biggest difference is the price though. The cost of an annual subscription for FactSet is around $12,000, for Capital IQ there is no standard price because it depends on the client and their needs. While there is no official data, based on data collected by Tagnifi , the cost can range from $5,000 per user to over $18,000 per user. Capital IQ is generally less expensive than Bloomberg Terminal but can potentially be more expensive than FactSet.
For companies planning to save a few thousand dollars, FactSet represents a reliable option in my opinion. Certainly, the gap with Bloomberg is obvious, but you cannot expect the same service for something that costs half as much.
In light of these considerations, therefore, it is not surprising that FactSet is still a relatively small company, even though it has achieved significant results for decades. Both Bloomberg and Refinitiv Eikon are still too dominant, and it will be up to management to succeed in nibbling more market share from them. Should they fail to do so, there is still an opportunity to grow while maintaining their current market share. The financial data service provider industry is worth $22.10 billion in 2023 and has been growing at a CAGR of 4.50% over the past 5 years: slow but steady growth. It is difficult to assume that it will come to a halt in the future given the pricing power of these four providers and how indispensable they are to industry professionals.
Finally, I conclude this paragraph with street estimates of FactSet's EPS.
Until 2026, double-digit annual growth is expected before slowing down in 2027. Such a growth rate could mean gaining market share.
Valuation
So far I have pointed out several times how interesting this company is, but it is not enough to buy it. Although the company itself is very sound, its price per share may be excessively high and eventually prove to be a bad investment.
To calculate the fair value of FactSet I will use a discounted cash flow whose inputs will be as follows:
- The expected free cash flow for the years 2023-2027 is calculated by considering street estimates of revenues multiplied by the free cash flow margin of the last 5 years, 27.86%. From 2027 to 2032, the CAGR will be 8%, and the perpetual growth rate 3%.
- RRR is equivalent to FactSet's cost of equity, or 8.69%. To get to this figure I considered a risk-free rate of 3.74% , monthly beta of the last 5 years of 0.826 and equity risk-premium of 6%.
According to these assumptions, FactSet's fair value is $310 per share, so the stock is currently overvalued, and not by a small margin. This is the main reason why I do not have any long position yet, but I do want to make an important point about it.
As we have seen so far, FactSet is a company that has demonstrated outsized fundamentals, with revenues and operating income growing for decades. Its market share is still relatively small; moreover, the free cash flow margin is often between 25-30%. The dividend grows quickly and buybacks are constant.
Companies with these characteristics are not common, which is why it may be necessary to pay a premium. I tend to buy a company only when it is below its fair value, but in this case, I would make an exception and start building a position already around $320 per share. Waiting for it to reach $250-$280 per share might mean never buying it, and I find that unreasonable since I believe so much in its long-term potential. A difference of $30-$40 might not be worth it for those who have an investment time horizon of 10-20 years.
The reason I say this is because in the past this company several times seemed overvalued, but in the end it still proved to be a good investment. I show you some examples based on the P/E ratio.
Since 2007, FactSet's P/E has almost always been above 20x, often above 30x; rarely has it fallen below 20x. In short, this is a company that typically has a high P/E even if its growth is not that high. Between 2012 and 2022, revenues had a CAGR of 8.60%.
- In March 2007 it might have seemed like a gamble to buy FactSet at a P/E of 38x, yet the stock has risen about 500% to date; the SPY has risen about 200% in the same time frame.
- Also in February 2011 FactSet looked overvalued with a P/E of 32x, yet since then the stock has risen about 290% versus 231% for the SPY.
I think I have made the point, and I would like to clarify that I have not made comparisons with relatively close time frames simply because I find it meaningless. FactSet's return has to be compared over long time horizons; one has to give the compound interest time to act. I recall that this company has a return on capital often in excess of 30 percent, and that is what makes its long-term returns sensational. In any case, even if we looked at the last two years, FactSet has outperformed SPY: about 19% versus about 1%.
Risks
Although FactSet's performance in recent decades has been excellent, this does not mean that it is a risk-free investment. The company has proven to be solid and steady in growth, but the same may not necessarily be true in the future. I have identified two risks for FactSet, one related to the market in which it operates and another related to the valuation I made earlier.
Regarding the first risk, I would like to dwell again in the financial data provider market, as I think there are other considerations to be made. While FactSet is seen as a cheaper alternative to Bloomberg, there are also cheaper alternatives to FactSet. After all, $12,000 per year is still a lot. For example, Koyfin is a young company created in 2016 and is gradually gaining acceptance in this market; the annual cost of its platform is only $840. Basically, cheaper alternatives are there, but obviously they are not always the best solution.
Just as a professional in the debt capital market would never change his or her Bloomberg Terminal for FactSet, similarly a professional in investment banking might consider not replacing FactSet. It depends on the situation.
The second risk I want to talk about concerns some of the considerations I made in my FactSet valuation. Earlier, I stated that this company requires a premium, otherwise one risks never buying it below its fair value. In any case, this is not a rule but simply my opinion. I could be wrong and FactSet could collapse to $250 per share in the future. At that point I would be happy to buy, but I would not be happy to have a major loss since I have already bought it before. In short, whether for you this company deserves a premium is not up to me, but to your personal considerations. The fact that I want to buy it at $320 per share is simply my choice.
Conclusion
FactSet is a company with all the conditions for me to invest in it:
- Revenues and EBIT growing year after year for decades.
- Potential for growth.
- High profit margins, high return on capital.
- Growing dividends.
- Buybacks over the long term.
Essentially, the shareholders are well remunerated, and this seems sustainable. The only flaw currently concerns the price per share, but after all, you can't pay cheaply for a company with these characteristics. I am quite surprised at how little it is talked about, but this may turn out to be an advantage in the end since it will not be targeted by speculators. I consider it an ideal company for those with a long-term view, for everyone else I don't think it is feasible since it is not very volatile. It is an investment that requires patience.
The risks of investing in FactSet are many and mainly related to competition, which might make one wonder if it actually does not have a solid competitive advantage, which Bloomberg does. Either way, I think its results are pretty clear evidence that this company knows how to improve, and that is what matters most to me. It is difficult to analyze this market in detail since the pricing of services offered in some cases is not crystal clear, and it also does not help that the market leader is not listed. It would have been interesting to make income comparisons between Bloomberg and FactSet.
Overall, given its current valuation, my rating for FactSet stock is a hold; I await the $320 per share.
For further details see:
FactSet Research Systems: Everyone Should Know About This Company