By nature, the stock market moves in fits and starts, lurching from obstacle to obstacle. Successful investors just have to learn to endure the ride. Barrack Obama had just won his November re-election bid when the December 2012 issue of Investor Advisory Service
went out to subscribers.
The macroeconomic picture remained a garbled mess of both promising and disappointing indicators. U.S. GDP grew at an annualized rate of 2.0% in the third quarter of 2012, which represented some acceleration yet remained well below historical averages. Housing was strong, with both selling activity and average selling prices rising together. The housing market seemed finally to have bottomed. Meanwhile, the Eurozone was not growing, and the picture in Japan was even worse. China, India, and Latin America continued to grow, but at a slower pace. The stock market seemed to be reflecting a dimmer economic picture overall. After a strong start to the year, the market was flirting with a 10% correction in the middle of November. But after that pullback, the market went on to “climb the wall of worry” throughout the rest of 2012 and 2013 (so far). From November 2012 through October 2013, the S&P 500 produced a total return of 27%.
We noted a year ago that investors had become quite underweighted in equities during the past few years, and we speculated that a lot of “nervous money” probably remained on the sidelines. We think absent investors returning to the stock market has been the biggest factor behind the market’s strong rise over the last twelve months. We don’t know whether this trend can continue, or whether the right move is to fade (go against) the general public. However, we’re not market timers. We think the market is always unpredictable, and we advise investors always to focus on what they can control: the quality of the companies they choose to invest in.
Let’s take a closer look at one of the companies featured in last year’s December issue, Global Payments Inc. (Ticker: GPN). Global Payments processes credit and debit cards for merchants, taking a small fee for each transaction. A processing network is expensive to build, but those high fixed costs are recouped by the millions of tiny, highly-profitable fee transactions that run across GPN’s network. While the network requires a heavy up-front investment, growing the business through adding incremental volume is not a capital-intensive process, so Global Payments’ business is characterized by excellent free cash flow.
Like most of the companies we feature, Global Payments has a proud history of double-digit sales and earnings growth. However, growth has slowed in recent years, which has led to P/E compression, meaning that the stock’s price appreciation failed to keep up with its underlying earnings growth. With a strong value case starting to emerge for this company, we saw an opportunity. The stock took a further hit in March 2012 when the company’s North American processing system suffered a data intrusion, which compromised 1.5 million credit and debit cards. Rectifying that breach cost the company $84 million in 2012, plus more than $55 million so far in 2013.
With shares trading at $41.87 and with a P/E in the low teens, we presented Global Payments as a sort of turnaround play. Normally, the term “turnaround” is applied to distressed companies, possibly struggling to survive. As growth investors, we view a value stock with the ability to reaccelerate growth in the future as a turnaround play.
This pick really shot out of the gate, outperforming the S&P 500 by about one thousand basis points (10%) through the middle of February 2013. The first fiscal quarter after our feature showed 11% revenue growth, with adjusted EPS up 5%. The subdued EPS growth was a little worrying, but some currency fluctuation came into play during the quarter. We expected the near future to show more acceleration.
In early April, the stock dropped 9% on the news that its fiscal quarter ended February 28th produced just 4% EPS growth. It’s hard for the stock market to overlook consecutive slow quarters, even when the company’s underlying prospects remain good. With shares now up just 7% since our feature, this pick was now trailing the strong general market. The company’s Fiscal Q3 did nothing to excite investors, and the pick continued to lag going into October 2013.
Then things turned up when the quarter ended August 31st, reported October 1st, showed 7% revenue growth with EPS up 10%. Much of this improved EPS growth actually came from a reduced share count, instead of improved profitability. The truth is that our turnaround story still hadn’t really materialized. However, one nice thing about value stocks is that management can often “manufacture” growth through share buybacks. In times when growth is hard to come by in the overall stock market, investors don’t always make a strong distinction between a stock growing its earnings organically versus one that grows EPS simply by shrinking the “S” (shares). GPN shares gained 12% the day the company announced its return to double-digit EPS growth. All of a sudden, our pick was nicely above water again.
At a recent price of $60.55, Global Payments has gained 45% since the time of selection, outperforming the S&P 500’s 27% gain during the same period. Stock picks that combine a decent growth story with a solid value case offer multiple ways for investors to win. For Global Payments, share price gains have come through a mix of buybacks, modest but still positive underlying earnings growth, and improved investor sentiment.