Issue #40: An emerging leader in enterprise software and an under-the-radar specialist rewriting the rules for building materials 🚨
We watch stock discussions on social media. We saw one recent discussion that caught our eye because it highlighted a mistake that’s common among retail investors.
The discussion involved “cheap stocks” and revolved around stocks with a low per-share price. This perception is misleading and can be damaging.
The belief that a low per-share price makes a stock “cheap” is, of course, an illusion. There is no material difference between buying one share of a $500 stock and buying 100 shares of a $5 stock or 500 shares of a $1 stock. You’ve invested $500. If the stock gains 10% you will gain $50.
What really makes a stock “cheap” or “expensive” is its price relative to a standard measurement, like earnings, sales, growth rate, or dividend.
When you buy a stock you are buying a percentage of a company’s future earnings. If a company’s stock price is low relative to its earnings, we say the stock is cheap. If a company is growing fast, many investors will accept a higher price relative to earnings (or losses), because they are evaluating the company by where it’s going, not where it is.
A company with high earnings but low growth might entice investors with dividends instead of future prospects. In that case, you could say a stock is “cheap” if its dividend yield - its price relative to its dividend - is high.
Valuation is a complicated business. You can study it for years and still have a lot to learn. It still starts with understanding that “cheap” is not about how high the share price is, it’s about the price relative to what you are buying. The challenge is to decide what you want to buy and how much you’re willing to pay for it.
Let's get into this week’s report:
- A fast-growing cloud software company dominating the enterprise management and HCM sector.
- A highly focused firm bringing triple digit growth rates in a “boring” industry.
Workday, Inc. ($WDAY)
$280.79 - Share price at time of writing
- Workday provides cloud-based enterprise applications for finance and human resources management.
- Workday customers include over 50% of the Fortune 500.
- From 2012 to 2021 sales growth has averaged 47% per year.
- Workday’s most recent quarter saw revenue growth of 19%. EPS beat estimates by over 57%.
What they do:
Workday is a leading global provider of cloud-based Human Capital Management (HCM) and financial management systems. Workday integrates enterprise management functions to prevent “software friction”, a common problem for companies who mix systems from different manufacturers.
Workday’s products fall into five categories.
- Financial Management software automatically translates business events into accounting data and generates insights for planning and evaluation.
- Human Capital Management solutions collect and monitor data from recruitment to promotion, providing human resource managers with the tools they need to support each employee.
- Enterprise Planning solutions allow integrated financial, workforce, sales, and operational planning, keeping all units on the same page.
- Spend Management solutions allow full control and automation of sourcing, supplier engagement, and analysis of spending data.
- Talent Management packages provide continuing skills inventories, eliminate bias in hiring, and support mentorship and personalized learning.
These products integrate seamlessly, creating an incentive for customers to adopt multiple packages.
Over 55 million people are currently using Workday products. Over half of the Fortune 500 are customers, including Dell, Comcast, GE, Humana, Netflix, Airbnb, Bank of America, Patagonia, Target, HP, FedEx, and thousands of others.
Workday delivers its products on a Software-as-a-Service (SaaS) model, generating continuing subscription revenue.
In March 2022 Workday acquired Peakon, which developed a system for generating employee feedback and using it to create actionable insights. This integrates a unique listening platform into Workday’s HCM software, a key competitive advantage.
What we learned from social media patterns:
$WDAY is not widely discussed on social media. A 3-month chart of social media mentions shows a peak after the most recent quarterly report, but at 14 mentions that peak is a long way below the baseline for trending stocks.
The low social media visibility may stem partly from the fact that Workday’s customers are large corporations. Most individuals have no dealings with the company and are not familiar with its products. Many have never heard of it.
The absence of a hype factor can make a stock less likely to shoot “to the moon”, but it also makes a stock less likely to take a dive in an economic downturn. The investors in the stock tend to be those that found it through research rather than through hype or trends.
Notable comments from Reddit:
“Why is no one talking about Workday? Because people on this sub only like hype things and HR software is the opposite of hype even if they are making insane amounts of money.”
“Dude Workday is the next big thing in cloud computing SaaS. It’s not particularly well known outside B2B circles, and is not a meme stock, so the volume is generally low and the market cap is relatively less (removed). I’ve been holding shares for ages and I think the price still has room to run.
I worked in the industry and know first hand that Workday has FAR superior sales and distribution channels than Oracle and SAP (the only two competitors).”
- [user deleted]
💸 Signal: Tiger Global has purchased 4.13 million $WDAY shares since 2020, with no sales.
Why $WDAY could be valuable:
The enterprise management software market is expected to maintain a CAGR of 9.5% through 2025.
The HCM software market is forecast to reach a CAGR of 9.3% through 2027.
Workday is a market leader in both sectors and is one of the only major SaaS players to offer financial management, sales, and HCM packages, enabling customers to integrate these functions.
Sales, revenue, and customer count show consistent high growth. Recent data show customer retention of over 95%.
Workday offers a product that can be sold to any enterprise in any business niche, cushioning the company against retrenchment in any single business sector.
The COVID-driven move toward remote work and distributed workforces have boosted demand for HCM products. This trend seems set to continue in the post-COVID landscape.
Workday has exhibited remarkably consistent revenue growth over an extended period:
Projected growth appears to be following the same trend:
Source: Seeking Alpha
Workday has beaten analyst earnings estimates for four consecutive quarters, exceeding the consensus estimate by over 57% in its most recent quarter.
Workday’s valuation metrics are generally greater than or similar to industry peers. The Company’s growth rate and product diversity are generally superior. Workday’s ability to offer integration across a wide range of enterprise management functions is a unique competitive advantage.
39 analysts cover Workday, assigning a consensus “Buy” recommendation. The average price target is $305.90, 9% above the current level.
What the risks are:
Enterprise management software is a highly competitive business. It is also a relatively new business. New competitors may emerge with more innovative products.
Enterprise management involves large amounts of confidential data. Any security failure or data breach or system failure causing significant downtime could compromise the Company’s reputation and competitive position.
Workday is not currently profitable and may fail to achieve or sustain profitability.
Workday’s current valuation is built on the assumption of continued consistent high growth. Failure to deliver the expected growth could adversely affect the stock price.
$WDAY is up over 12% in the last month and its price momentum could be nearing a resistance level.
Bottom line: $WDAY is a leading player in a high-growth industry and has established a remarkably consistent long-term growth trend. Keep an eye on its upcoming quarterly results on Nov. 18.
Encore Wire Corporation ($WIRE)
$112.89 - Share price at time of writing
- Encore Wire manufactures and sells electrical building wire and cable products.
- Encore has driven higher growth than its industry sector through industry-leading order fill rates and responsive customer service.
- Net sales for the first nine months of 2021 were up over 668% from pandemic-constrained 2020 levels. EPS grew over 734%
- $WIRE is pursuing an aggressive (but debt-free) capital investment program aimed at expanding production, raising efficiency, and improving margins.
What they do:
Encore Wire manufactures and sells electrical wire and cables. The Company’s products are used in homes, apartments, manufactured housing, commercial and industrial buildings, and data centers.
Encore maintains a single vertically integrated administrative and manufacturing center in McKinney, TX. The Company has a highly automated production facility and an integrated manufacturing process, allowing effective cost control.
Encore’s competitive strategy is built on strong customer relations and rapid handling of orders and shipments.
Encore pioneered the use of color-coded wire and cables, reducing installation and inspection times and improving safety. The patented SmartColor ID system allows instant identification of gauge, number of conductors, wire, and jacket types.
Encore has also developed light, durable cases and reels that allow fast, tangle-free wire pulls,improving job site efficiency. The Company has multiple patents and patent-pending developments, ranging from process improvements to more efficient packaging.
Innovation and customer service have allowed Encore to rapidly increase sales and market share.
What we learned from social media discussion:
$WIRE has had 2 social media mentions in the last three months.
In some ways this is not surprising: wire and cable are not products likely to fire up passions in a place like Wall Street Bets, and Encore Wire is not exactly a household name.
In some ways the silence is surprising. $WIRE has, in Reddit terms, gone to the moon and delivered impressive returns without being noticed. That is a bit unusual. You would expect a 60% gain in 3 months accompanied by high triple-digit revenue and earnings growth to get some attention no matter what the company does.
This is the ultimate under-the-radar company, at least as far as retail investors are concerned.
💸 Signal: Blackrock and Vanguard hold a combined total of almost 5.4 million shares of $WIRE. Over 95% of the float is held by institutions.
Why $WIRE could be valuable:
The North American wire and cable market is expected to generate an 8% CAGR through 2026.
The building construction market, the primary driver of Encore sales, is expected to show a CAGR of 5% through 2024.
Encore is well-positioned to increase its market share. Because its products are manufactured in the US at a single location, the Company is experiencing minimal disruption from the logistics crisis of 2021. The Company’s priority on customer service, agile operations, and industry-leading delivery times is an attractive proposition at a time when companies across the US are struggling to meet orders.
Encore maintains a low-cost manufacturing operation and the one-campus model reduces distribution and freight costs and provides a high degree of control over potential logistics bottlenecks. The Company has a great opportunity to take market share from competitors who rely on imported finished products that are delivered in containers and affected by port congestion.
The Company’s exclusive focus on a single product type allows a high degree of efficiency and innovation. While wire and cables are not generally seen as sophisticated products, $WIRE has focused on manufacturing process improvements and packaging that allows rapid, convenient deployment on job sites, which is a high priority for end-users.
$WIRE has beaten earnings estimates for five consecutive quarters. Q2 2021 EPS of $8.82 beat the $1.14 consensus estimate by over 673%. Q3 2021 EPS of $8.51 beat the $2.91 consensus estimate by over 192%.
The Company repurchased 393,379 shares in Q3 2021 and paid its first-ever dividend in October 2021.
Year-over-year growth rates are somewhat distorted by the pandemic, but revenue growth over the past 5 years has averaged 18.45%. That is well above the industry CAGR and indicates that Encore is expanding its market share. Even during the pandemic, Encore remained profitable.
$WIRE has gained over 132% in the last year and is still trading at very reasonable valuations. The trailing P/E is only 8.65 and the stock trades at only 1.22 times TTM sales. There is effectively no debt, the operating margin is a solid 18.22, and ROE is an exceptional 29.03%. The Company’s exceptional revenue and earnings growth rate could support substantially higher valuations.
What the risks are:
Encore Wire depends heavily on residential and commercial construction to generate demand for its products. A significant downturn in construction could severely limit growth.
Encore requires continuous access to new and recycled copper. Changes in the availability and price of copper could affect Encore’s product prices and manufacturing capacity.
$WIRE shares are currently trading at an all-time high. Over 90% of the float is held by institutions. If institutional holders decide to take profit the share price could be affected even if growth momentum continues.
Encore operates in a highly competitive business. The Company maintains an excellent competitive position but to justify its stock price it will need to continuously increase market share. If it fails to achieve that goal the share price could be affected.
Bottom line: Encore Wire is a highly competitive, well-managed specialist company delivering exceptional growth rates and trading at a reasonable valuation.