🗞 These 4 High Quality Companies Are Trading At Record-Low Valuations

Happy Sunday! 👋 

Today we’re taking a look at 4 high quality companies trading at their cheapest valuations in more than 10 years.

Let’s dive in!

Featured Story

4 Quality Companies At Record-Low Valuations

This has become somewhat of a recurring post here at the Fiscal.ai Sunday Newsletter.

Every once in a while, companies that were once believed to be high quality fall out of favor with the market. And in recent months, many of those companies belong in the software sector.

Due to worries of “AI disruption”, some of the highest quality businesses in the world are now trading at some of their lowest valuations in a decade.

As always, “quality” is subjective and different investors define it in different ways. However, as a general rule of thumb, if a company can earn high returns on invested capital (ROIC) for extended periods of time and has ample room to reinvest capital, then that’s a pretty high quality business.

Here are 4 companies that fit into that bucket:

1. Adobe

Adobe seems to be one of the most hotly debated companies in the world at the moment. Text-to-image and text-to-video models have called into question the staying power of Adobe’s creative software tools.

However, while investors might argue about their competitive positioning, Adobe’s financials are irrefutable. Since Adobe first began its shift to a cloud-based model in 2011, the software giant has increased its revenue from $4.2 billion to $23.8 billion and expanded its operating margins from 26% to 37%.

This has helped the software giant produce an average ROIC of 31% over the last decade. That’s more than triple the S&P 500’s average.

The recent AI pressure has left Adobe trading at its cheapest earnings multiple in more than 10 years.

2. Constellation Software

Constellation Software is a serial acquirer of vertical market software companies. They are home to more than 1,000 different niche software providers that provide mission-critical solutions to specific end markets.

In isolation, these are not glorious businesses.

They have low barriers to entry and often serve very, very small addressable markets. I’m talking software for chicken coop management, cemetery mapping, public transit scheduling, and more.

In aggregate, however, these businesses generate consistent and predictable free cash flow. And since there isn’t a whole lot of competition for acquiring companies this small, Constellation Software is able to buy them at attractive prices.

This has enabled Constellation to generate ROIC above 15% over the last 10 years.

Over the last 6 months, shares of Constellation have collapsed more than 50% due to fears that their suite of businesses will be vibe-coded into obsolescence. This has left one of the most successful serial acquirers of all-time trading at its lowest multiple in a decade.

3. Veeva Systems

Veeva Systems is the dominant provider of cloud software for the life sciences sector. Their solutions span virtually the entire drug development and commercialization lifecycle.

Most vertical-specific software tools require custom solutions designed for their particular industry, and in the case of biopharma, that’s especially true. Veeva's products are purpose-built to meet stringent global regulations. Given that biopharma companies manage sensitive clinical trial data, opting for a new entrant or unproven provider is a risk that most aren’t willing to take. That’s why 47 of the top 50 biopharma companies are Veeva customers.

As the industry leader, Veeva has been able to sustain an average ROIC of 37% since 2012. Revenue, meanwhile, has grown from $61 million to $3.1 billion. 

Despite the high regulatory requirements necessary to serve the industry, it still hasn’t stopped investors from selling the stock amidst the recent AI worries. The stock has dropped 42% in just the last 4 months, and is now trading at its lowest multiple ever.

4. ServiceNow

Of all the software stocks that have fallen out of favor in recent months, few have fallen as hard as ServiceNow. The software giant is now in its largest drawdown ever (-57%) and has shaved off $95 billion in market cap over the last 4 months alone.

ServiceNow describes itself as the “central nervous system” for enterprises as its platform is often the system of record for multiple departments across large organizations. Once embedded in a company, ServiceNow becomes foundational to a business which is why they report a 98% renewal rate, one of the highest of all global software companies.

Since 2012, ServiceNow has grown revenue from $244 million to $13.4 billion. They’ve also earned exceptional cash flow growth ($7 million to $4.6 billion) on relatively low invested capital. Their free cash flow ROIC has averaged 37% over the last 10 years.

Now free cash flow does exclude stock-based compensation (SBC), and over the years, ServiceNow has been a chronic user of SBC. While many investors might point to this with concern, the argument could be made that it was actually the right thing to do while their stock was trading at lofty multiples. In fact, despite spending 18% of its revenue on stock-based compensation over the last 5 years, share count has only risen by 1.3% annually.

This minimal dilution and impressive ROIC has enabled ServiceNow to grow its free cash flow per share by 31% annually over the last decade.

However, as with almost all software stocks today, investors appear spooked that AI will enable more competition for ServiceNow and encourage more ServiceNow customers to build solutions in-house. This has left the stock trading at its lowest valuation since going public in 2012.

That’s all for this week. 

If you have any questions or if you’ve found more quality companies trading at record-low valuations, feel free to send them our way by simply replying to this email!