The Top 20 Values in Software

Study after study has shown that stocks with low price-to-earnings multiples significantly outperform high P/E stocks. Research from my favorite investing guru, NYU professor Aswath Damodaran, pegged the outperformance at anywhere from 9% to 12% per year, depending on the study period. That's big money we're talking about.

But you already know that you can't just go out and buy the stocks with the lowest multiples. Companies can trade at dirt cheap prices for a number of dire reasons, including low growth prospects, skepticism about earnings, or high risk of bankruptcy.

These dangerous stocks can quickly crater. Buy too many of them, and you'll increase your own risk of bankruptcy!

Thus, for a company to be truly undervalued, Damodaran says in his book Investment Fables: "You need to get a mismatch: a low price-to-earnings ratio without the stigma of high risk or poor growth."

Of course, you're unlikely to find any high-growth, low-P/E companies out there. But Damodaran suggests setting a reasonable minimum threshold for earnings growth, such as 5%. There are also various ways to minimize risk, including staying away from volatile stocks or companies with dangerous balance sheets.

The screen's the thing
We're looking for companies with low price-to-earnings multiples, but also a relatively low amount of risk, and the potential for reasonable growth. Our screen today will cover the best value plays in the software and services industry, as defined by my nifty Capital IQ screening software.

There are 176 such companies with market caps topping $500 million on major U.S. exchanges. They have an average forward P/E of 27.7. Here are my parameters:

  1. To stay away from bankruptcy risk, I used Damodaran's suggestion and only considered companies with total debt less than 60% of capital.
  2. In hopes of capturing a reasonable amount of growth, I looked at Capital IQ's long-term estimates, and kept only companies expected to grow EPS at 5% annually or better over the next five years. Furthermore, I required at least 5% annualized growth over the past five years.

Of the 42 companies passing the screen, here are the 20 with the lowest forward price-to-earnings multiples:

Company

Market Cap
(in millions)

Forward P/E

Debt-to-Capital

Estimated EPS
Growth

Computer Sciences (NYSE: CSC  )

$7,616

9.1

37%

8%

Microsoft (Nasdaq: MSFT  )

$217,731

10.8

12%

12%

SAIC (NYSE: SAI  )

$5,858

11.2

33%

11%

CA Technologies (Nasdaq: CA  )

$11,243

11.4

23%

9%

ManTech International (Nasdaq: MANT  )

$1,487

11.6

18%

13%

JDA Software Group (Nasdaq: JDAS  )

$934

11.8

32%

12%

Open Text (Nasdaq: OTEX  )

$2,640

11.8

25%

14%

CACI International (NYSE: CACI  )

$1,388

11.9

31%

13%

CGI Group (NYSE: GIB  )

$4,240

11.9

16%

14%

Broadridge Financial Solutions (NYSE: BR  )

$2,687

13.1

29%

11%

Fiserv (Nasdaq: FISV  )

$8,331

13.2

52%

12%

Global Payments (NYSE: GPN  )

$3,060

13.8

31%

13%

NeuStar (NYSE: NSR  )

$1,873

13.8

3%

13%

Oracle (Nasdaq: ORCL  )

$143,977

14.6

34%

14%

Wright Express (NYSE: WXS  )

$1,450

14.7

19%

11%

Accenture (NYSE: ACN  )

$29,034

15.0

0%

11%

MAXIMUS (NYSE: MMS  )

$1,064

15.3

0%

15%

BMC Software (Nasdaq: BMC  )

$7,829

15.3

22%

15%

Mastercard (NYSE: MA  )

$31,474

16.1

0%

18%

Ebix (Nasdaq: EBIX  )

$831

17.5

20%

13%

Source: Capital IQ, a division of Standard & Poor's.

There are lots of good research candidates here -- I expanded the list to 20 so you could find some companies you were interested in. To further stack the odds on your side, Damodaran says you can eliminate any companies that have restated earnings, or had more than two large restructuring charges over the past five years. And if volatile swings in price cause you to lose sleep, consider only companies with betas less than one.

What about companies in other industries? Check my archive for my past screening results, and watch this space for more over the coming days.

Fool analyst Rex Moore will be signing autographs in the back until closing. Of the companies mentioned here, he owns shares of Microsoft. Accenture, Microsoft, and SAIC are Motley Fool Inside Value recommendations. Ebix and Open Text are Motley Fool Rule Breakers selections. The Fool owns shares of and has written puts on Broadridge Financial Solutions. Motley Fool Options has recommended writing puts on Ebix. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Ebix, Fiserv, ManTech International, Microsoft, Open Text, and Oracle. Try any of our Foolish newsletter services free for 30 days.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


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