FactSet Stock beats the market in 2022. Is it a buy?

Slow and steady is rarely equated with sexy, crushing returns in the market. And that’s really a shame. Companies that are able to manage modest revenue growth but superior profitability are often those overlooked gems that deliver huge returns on investment.

Take FactSet Research Systems (SDS -0.11%) for example. Financial software stock is up 17% over the past year, compared to a negative return of 12% for the S&P500. FactSet has also beaten the market over the past five and ten years – up 148% from the S&P 500’s 59% and 342% from the S&P 500’s 187%. The company’s recent earnings release illustrates how it’s doing and how it could continue to beat market returns for years to come.

Data is essential for finance

FactSet is often categorized under fintech companies, but it may be more accurate to categorize it under cloud software providers, even though it focuses on the financial industry. The name of the company alludes to what it does. Its software helps with market research and analysis for investment managers, banks, insurance companies, and more. And for businesses in general, FactSet also provides tools to help research industries and individual businesses within them.

Although FactSet has been around for decades, its software is top-notch. For those familiar with how the cloud works and the importance of data management, it should be noted that Snowflake (SNOW 2.87%) recently named FactSet the 2022 Financial Services Industry Partner of the Year. Snowflake said FactSet’s flexibility to help joint customers manage and store their information is what makes it an ideal software provider.

Since it’s a seasoned company, it’s not exactly high-growth. FactSet said the annual subscription value (ASV) of its software and services on an organic basis, excluding acquisitions and divestitures, increased 10% year-over-year in the third quarter of fiscal 2022, the three months ending in May. This is well below the growth rate of these high-flying young peers in the fintech and cloud industries. But as a mature company, FactSet is primarily concerned with management profitable growth, rather than growth at all costs. And this software company is uniquely good at driving profitable growth and returns on investment.

Software synergies

Like many other software providers, FactSet has built itself over the years into a type of software platform – a provider that provides a set of tools rather than a single product to its customers. With a platform and supporting infrastructure in place, it is able to acquire smaller peers, connect them to its ecosystem, and derive higher profitability from them.

FactSet has been a serial acquirer for years and has done a great job handling these integrations. It is now in the process of implementing two new prices: Cobalt Software, purchased in October 2021, and CUSIP Global, purchased in December 2021. Cobalt was designed for venture capital and private equity firms. He assists with portfolio monitoring and M&A opportunities. CUSIP was purchased from another financial data company S&P Global (SPGI -1.17%). CUSIP is the system used to identify securities – stocks, bonds, funds and others – and to clear their transactions between brokers and financial institutions.

These two purchases boosted FactSet’s revenue well beyond the 10% organic growth in ASV recorded last quarter. Factoring in additional Cobalt and CUSIP sales, FactSet’s revenue jumped 22% year-over-year to $489 million.

But here’s the beauty of bolting new software onto an existing platform. Adjusted operating profit grew at an even faster rate than revenue, recording a nearly 42% year-over-year increase to $179 million – an operating profit margin unbelievably lucrative adjusted by almost 37%. The result is a company that has historically generated significant and rapidly growing free cash flow.

Data by Y-Charts.

FactSet tends to increase shareholder returns over time through share buybacks, but for now these are on hold until mid-fiscal 2023 or later while the company repays the debt, some of which came from these last two acquisitions. It had $527 million in cash and short-term equivalents and just under $2.1 billion in long-term debt at the end of May. It’s not imperative that it pay off that debt, but it’s definitely a good idea if FactSet is considering making any further acquisitions. But when stock buybacks start again, perhaps from the start of calendar year 2023, it will be good news for investors.

At this point, FactSet is trading for a premium of 30 times last 12 months free cash flow and 27 times next year’s expected earnings. If you’re looking for a high-value stock, this isn’t the one. However, given the company’s long track record of growing profits at a faster rate than revenue and returning cash through share buybacks and a small dividend – the current yield is by 0.9% – FactSet Research is absolutely worth a look for long-term investors. Expect some volatility due to the current economic environment, but FactSet could continue to beat the market over the next decade.

Nicholas Rossolillo and its clients have no position in any of the stocks mentioned. The Motley Fool holds positions and recommends FactSet Research Systems, S&P Global and Snowflake. The Motley Fool has a disclosure policy.

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