Motley Fool’s Next Breakthrough: “Vertical Cloud” or “Industry Cloud”

What "First Mover" is recommended by Motley Fool Canada for "Winner Take All" cloud profits?

By Travis Johnson, Stock Gumshoe, September 20, 2016

The Canadian branch of the Motley Fool has been pitching a cloud computing stock that they say is “breaking out” right now, and the spiel is all about the next transition in cloud computing, from “general cloud services” to those that are specifically designed for one industry or customer group.

So what’s the stock? Well, they’d like you to sign up for Stock Advisor Canada to find out… but we like to bypass that bit, of course, so we’re going to sniff around, dig up the clues, and ID the stock for you. Then you can think for yourself and start off with a fighting chance at a balanced perspective on the stock.

You’ve probably heard me say this before, but there are always some new folks about so I’ll digress for a moment — one of the reasons we like to reveal these “teaser” stocks is that our psychology works against us in these kinds of situations in two major ways:

First, if you subscribe to a newsletter to learn about a stock, your brain is going to twist itself into knots trying to prove to itself that you were brilliant to subscribe… which means you’ll be inclined to buy the stock without doing much research; and,

Second, it’s well supported by research that investors are “anchored” to the first thing they learn about a company — if the first piece of research is negative, it’s hard to overcome that… and likewise, if the first piece is aggressively positive (like many teaser ads) it’s hard to shift your perspective to be more critical.

The Gumshoe way: See the crazy hyped-up teaser ad, then learn about the stock from us and try to have a bit of a rational analysis or discussion about it… we think that gives you a fairer shot at being smart. Doesn’t mean you’ll be right all the time, of course, or that the stocks will be good or bad… just gives us a better opportunity to think clearly and rationally. After that, if you want to subscribe to that newsletter or any other, go right ahead. Some are great, some are lousy, it depends on what interest you and how much you enjoy reading their analysis… and, of course, on how well-timed their stock picks happen to be during the time you subscribe, once you get past the ridiculous claims some of them make in their ads, which set impossible expectations, many newsletters are valuable and worthwhile for many investors.

Back to the point, though — what’s this “Cloud Computing” Stock?

Here’s a taste of the ad:

“It’s an industry where a disruptive, first-mover company could be the ‘winner-take-all’…

“Fortunately, we think we’ve found that first-mover company.

“(It’s already up over 48% since we recommended it in Stock Advisor Canada, while the market has returned just 7.6%.)

“And customers of this mid-cap sensation are already calling it a ‘dream solution’ and saying it’s ‘a big leap forward.’

“Because this breakthrough in cloud computing is when companies transition from general cloud services – forget Amazon and Google — to cloud services that are specifically designed and architected for a single industry.”

The comparisons are made to a few consumer-focused cloud applications, OpenTable and Zillow, which you’ve quite possibly been happy to use if you’re interested in restaurant reservations or real estate.

And then some more clues:

“… it already has partnerships with more than 198 different companies, and works with 33 of the 50 largest companies in its sector.

“It’s growing so rapidly that it’s hard to even keep up with the numbers… but I will tell you that it’s beaten its earnings estimates for eleven straight quarters – since it went public in 2013….

“The company is barely a few years old in the public markets, and is still – shockingly and to our delight – trading close to where it IPO’d in 2013.”

This particular “vertical cloud” company is operating, we’re told, “in one of the most powerful and prestigious industries in the world.”

So what is it? This is Veeva Systems (VEEV), which is indeed a provider of cloud CRM and other cloud services to healthcare and pharmaceutical customers.

And yes, they are priced pretty close to where they were following their late 2013 IPO — just over $40. And they have consistently grown for those two years, but the growth hasn’t yet been particularly dramatic and costs have easily kept up with revenues… the last year’s earnings have plateau’d a bit, which is perhaps what kept the share price down for a while.

The stock has been picking up lately, though whether you think of that as a “breakout” is your call to make — and that’s probably because analysts have been raising their estimates for the end of this year and for next year. If VEEV hits those analyst forecasts, they would post something like 22% earnings growth next year and 25% growth in the following year, which is impressive even for a relatively small company… and enough, apparently, to get growth investors interested again.

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That means the current valuation, if you use next year’s estimates (their next fiscal year starts at the end of January) is not exactly cheap at 53 times forward earnings (or 42X earnings if you use the 2018 estimates)… but perhaps you can justify it if you think they’re going to accelerate earnings growth in future years and turn into a strong cash-flowing machine, either by increasing sales much more rapidly or by scaling back on their big marketing and R&D spending.

That’s a judgement call you’d have to base on understanding the company, not just the reported or forecasted financials — you’d have to look at the business and try to understand how they’re growing, what the competitive landscape is like, and whether you think they’ll be able to “win” customers and expand their customer relationships without having to spend a lot more… or, alternatively, you might come to the conclusion that the market for their products and services is so huge that they should be reinvesting all this cash flow into taking market share right now, while we’re still pretty early into the transition to electronic records, cloud services, etc. in the healthcare space.

For me, in skimming the financials and not really looking at the company’s real business just yet, what stands out is that spending boom — this is a stock that you’d invest in because you think it’s going to grow fast (or grow for a very long time), and over the past year the trailing twelve month growth numbers look like this:

Revenue: 23.65%
Gross Profit: 24.75%
SG&A Expense: 42.44%
Earnings per share: 11.76%

Revenue growth is great, and the cost of goods is not a problem (gross profit is rising roughly as fast as revenue — which is not great for a software company, since you’d expect margins to improve as sales rise, but it’s at least not a negative). What stands out is that rapid growth in Selling, General and Administrative expenses, which has consistently outpaced the revenue and earnings growth for all of Veeva’s relatively short life as a public company. And they’re not teensy, they do have a market cap of $5 billion already.

That’s why the earnings per share hasn’t grown very much, it appears, because they’re spending a lot more on selling and overhead costs per sales dollar than they used to. So if you want earnings growth, either that SG&A number has to come down in relation to revenues, or the revenue number has to go up a lot faster.

And that’s as far as staring at the numbers can take you — beyond that, you’ll have to look into the company and see if you think they’re really at an inflection point for earnings growth starting in the next couple quarters, which is what analysts believe… or you think they’ll disappoint again on those growth numbers.

The company has not done poorly or been terribly disappointing when it comes to earnings, they have pretty consistently beaten the analyst earnings estimates by at least a little bit… but VEEV is probably suffering a bit from the fact that they went public as a “cloud” name when everyone was buying up anything with the word “cloud” in it, and investors overpaid for a company that wasn’t really on a proven growth trajectory yet. They have continued to introduce new products and post steady top-line growth, including in the most recent quarter announced here, so perhaps it’s just that the growth and expectations are finally coming a bit closer together.

There has never been any meaningful insider buying at Veeva Systems, which isn’t unusual for a newly public company (everyone’s still focused on cashing out on years of stock options or grants, which are a major part of their compensation but weren’t really easy to monetize until the IPO), and the institutional and fund ownership has stayed about the same.

So go forth, research the business, and see if you think it’s going to grow for a long time. My quick assessment is that they have a high quality business, with good recurring revenue and a pretty strong subscriber base among major pharmaceutical companies, particularly, and no particular red flags in their financials… but that you’re paying a lot for that quality business given the existing growth rate.

Which really just means you’d probably have to put a fair amount of faith in forward analyst estimates of potential growth to make the price palatable. That’s not necessarily an indictment, you could say the same about a lot of growth stocks, but I’d consider VEEV’s earnings growth trajectory so far as a public company to be disappointing… so I’d look for reasons for future optimism that overcome that disappointing reality before considering a purchase of this particular stock. Listen to the conference calls, review their presentations, see what the competition is doing, etc.

Your opinion might differ, of course, and I don’t have a lot of conviction on this one — I’d love to hear what you think of Veeva, just use the friendly little comment box below. Thanks!

P.S. No, in case you’re checking, Veeva is not Canadian — the folks at Stock Advisor Canada have wisely not restricted themselves to just Canadian investments, so they make two recommendations each month, one Canadian stock and one US stock. This is presumably a recent pick on the US side of the ledger for them.

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