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Figuring out which shares to consider buying isn’t always straightforward. But I’ve got a method I use for trying to find long-term opportunities, whether the stock market’s up or down.
There are two parts to it. The first focuses on the business and its competitive position and the second involves trying to work out what price to buy it at.
Part 1: the business
In my view, the most important thing when it comes to investing is the underlying business. And as a long-term investor, I’m looking for companies that can endure well into the future.
This means I’m trying to find organisations that have something that can keep them ahead of any potential competitors for a long time. And Experian’s (LSE:EXPN) a good illustration of this.
The FTSE 100 credit bureau has a vast database of information about potential borrowers. And importantly, it’s virtually impossible for a new entrant into the market to replicate this.
Experian’s business involves using an algorithm licensed from Fair Isaac Corp (FICO) to generate a credit score for potential borrowers. It then sells both the score and the data to mortgage resellers.
Recently though, FICO’s said it plans to license its score directly to resellers, bypassing Experian (as well as Equifax and TransUnion). But I think this reveals the FTSE 100 company’s strength.
Even with FICO going direct to resellers, Experian’s data is indispensable for resellers looking to generate a FICO score. So while it’s a potential disruption, it shows the value of the firm’s data.
Part 2: valuation
Working out what gives a company strong long-term prospects though, isn’t the one part of how I evaluate stocks as potential buys. If it was, investing would be a lot easier.
Shares in even the best business can be bad investments if they’re bought at the wrong prices. So the second part of my process involves thinking about valuation.
In the case of Experian, the stock trades at a price-to-earning (P/E) ratio of 36. That seems very high, but a closer look at the company’s financials reveals something very interesting.
Over the last 10 years, the firm has consistently generated more cash than its official net income. And this is true even adjusting for the non-cash costs that result from using shares to pay staff.
Adjusting for this, Experian shares are currently trading at a multiple closer to 23. That’s still well above the FTSE 100 average, but it’s significantly lower than it initially seems.
The trouble is however, FICO looking to go direct to mortgage resellers is likely to cut into sales. And the current multiple arguably reflects expectations of earnings growing, not contracting.
Should I buy it?
Experian’s in an interesting position at the moment. The threat of FICO licensing its algorithm directly to mortgage resellers is something I’m thinking about carefully.
The effect of losing revenue from FICO scores could be significant on the firm’s bottom line. But resellers will still need the FTSE 100 company’s data.
There are still gaps I need to fill in my analysis of Experian and the value of its database without FICO scores included. I think however, taking a closer look could potentially be very rewarding.
This story originally appeared on Motley Fool
