Down 25% in 2020, This Growth Stock Looks Like a Great Value

It's no secret that technology stocks have sold off in the last few months, and industrial technology company Trimble (TRMB 1.71%) is one of them. But when looking for potential "buy on the dip" candidates, it's important to distinguish between speculative growth stocks that promise a blue sky, and real companies with real earnings, cash flow, and growth prospects. Trimble is the latter, and its recent dip is creating a buying opportunity.

Trimble has real earnings

The company's core technology provides positioning, modeling, and data analytics across a range of industries. As such, Trimble connects a customer's physical assets to the digital world to improve their performance. Think of mapping and geospatial companies, trucking fleets modeled in real time, construction and infrastructure projects completed on time with less waste, or farmers using precision agriculture to increase crop yields.

Image source: Getty Images.

Trimble's technology helps customers do all of these things right now. So the question is not whether it will be a profitable company, but does its growth prospects justify its valuation? I think the answer is yes. 

Trimble's growth prospects

The likelihood is that increasing adoption of digital technology and improvement in analytics capability will only grow over time. For example, as more construction and infrastructure companies discover that Trimble's technology helps ensure contracts will complete on time, they will see the financial benefit of avoiding costly overruns. Similarly, the building industry is a significant contributor to carbon emissions, and Trimble's solutions can also help eliminate waste in the construction process.

Digital and analytics adoption is an opportunity for revenue growth and margin growth as Trimble can increase its higher-margin recurring-services revenue as a share of income. The idea is that the company will become part of an integrated work process with its customers.

In addition, management is transitioning toward subscription-based software revenue rather than a perpetual software model. It's a well-worn path in the software world. Still, it usually results in near-term revenue and margin pressure because revenue and earnings are recognized over many years rather than up front with a perpetual license model.

Where the business is heading

Putting all these points together, it's clear that monitoring the evolution of the business, at least in terms of headline numbers, requires a high-level perspective. That's a viewpoint outlined by CEO Rob Painter on the recent earnings call.

He asked Wall Street to look "at the growth in the ARR, the look on our cash flow, the net working capital as factors to complement what an EBITDA percentage or an operating income percentage will tell you, because it's an incomplete story."

Image source: Getty Images.

Don't be overwhelmed by the acronyms. ARR means annualized recurring revenue, representing the annualized value of recurring revenue including subscription, maintenance and support revenue, and term-license contracts for the quarter. It's an excellent way to measure the success of the plan to transition to subscription revenue and grow long-term earnings. EBITDA is simply earnings before interest, taxation, depreciation, and amortization: a traditional measure of earnings.

Whichever way you look at it, Trimble is a double-digit-growth business. Organic ARR rose 12%, and free cash flow growth would have been even higher if the company hadn't had to make inventory purchases at relatively high prices in the fourth quarter, when free cash flow fell by $36 million.

Data source: Trimble presentations.

Everything points to a business in growth mode, and management's guidance for 2022 calls for an 8% to 11% revenue increase.

Not all plain sailing

That said, Trimble still faces some headwinds in 2022. For example, chief financial officer David Barnes conceded that "we're going to see more inflation than we had anticipated in the first half of 2022" as high raw material prices and supply chain issues continue through 2022.

Moreover, Barnes sees profit margin headwinds from the shift to subscriptions (as discussed earlier) and investments made to accelerate ARR.

As such, it's a good idea to focus on ARR as the key metric to monitor. On that front, investors can feel good because management guided toward mid-teens ARR growth by the year-end.

A stock to buy

All told, whichever metric you look at, Trimble looks like a double-digit growth business with a long-term growth opportunity within exciting end markets. If ARR hits its targeted growth rate by the end of the year, it's fair to call Trimble a mid-teens growth business.

Given that Wall Street analysts expect $761 million in free cash flow, Trimble trades at 23.4 times its forward free cash flow. That's a reasonable valuation for a company growing its vital metric at a mid-teens rate.