Morningstar: Why some stocks are too good to be true
Stock picking is always tricky, even when you find two companies with stable business models and sticky client bases; it’s perhaps worth remembering that only fools rush in.
Brett Horn, Equity Analyst at Morningstar, highlights two bank technology companies: Fiserv and Jack Henry. The base of their businesses is called core processing, one of the most common day-to-day systems that banks use to operate. The two companies leverage these basic captive relationships to cross-sell supplementary services such as electronic bill payment and online banking. The result is a stable business model, with around 85% recurring revenue under long-term contracts.
Even during the crisis these two banks did well, they were able to maintain basically flat revenue. Since then they have had a steady improvement in growth. Despite the stability of these two companies Brett Horn believes that people who are looking at their stock today are facing a valuation risk due to the richly valued market price on these stocks.
The market price implies a continued improvement in growth rates, which is not necessarily realistic, even in a promising environment. The growth rates Fiserv and Jack Henry can achieve are limited by the fact that they serve a very mature industry.
