Donnelley Financial Solutions (DFIN 0.83%) is a dominant player in helping companies comply with SEC regulations. The company holds a No. 1, 2, or 3 position in all its highly cyclical markets. Donnelley knocked it out of the ballpark in 2021, thanks to the red-hot IPO market and an even hotter once-in-a-lifetime SPAC market. Since then, the stock has come down, and shares look cheap -- but only on paper. 

A great year for red tape

Donnelley Financial Solutions has an envious customer list that boasts more than 300 S&P 500 customers 

and over 700 Fortune 1000 customers. These customers use Donnelley's software for SEC compliance filing and transactional filings for things like IPOs, M&A, and new debt securities. Most of their customers have been with Donnelley for many years. 

When the IPO and SPAC markets gained momentum in 2021, so did business for Donnelley. In 2021, transactional revenues jumped over 40% in 2021 to $416 million, well above the six-year average of $300 million. Because Donnelley's services are mostly automated, that extra revenue came with few additional costs. Adjusted EBITDA margin for Donnelley nearly doubled from 9% in 2020 to 17% in 2021

As the calendar turned to 2022, the SPAC market cooled, and Donnelley's transactional revenue may follow suit. There were 613 SPAC IPOs in 2021, but only 58  through the first quarter of 2022. After the SEC proposed additional investor disclosure on SPACS, that number could fall even further. There are still SPACs that need to merge with a target, and Donnelley will get that business --unless those SPACs close up shop and return cash to shareholders. Either way, the end looks near for SPACs and Donnelley's SPAC-related profits.

In addition, the IPO market has cooled as well. In the first quarter of 2021, 395 IPOs  hit the market, but 2022 has been a different story. Only 77 arrived in the first quarter of 2022. In recent months, 2021 IPOs have performed poorly as the stock market tanks. If the market continues its downward trend, companies thinking about IPO'ing may reconsider as their hoped-for share price goes up in smoke.

Don't forget that the same operational leverage that provided Donnelley with margin expansion in 2021 works the same in reverse. In other words, if transactional revenues fall, margins likely will, too, as lower revenue covers the same fixed costs. 

Regulate your excitement 

Donnelley Financial is undoubtedly strong, in its market position, its industry, and apparently its valuation. The stock trades at a non-GAAP TTM P/E around 6, well below its five-year average of nearly 10. Looks awfully tempting, right? But consider that over the five years from 2016 to 2020, Donnelley's average diluted earnings per share were $0.92. In 2021, diluted earnings per share were $4.14.

Donnelley shares currently trade around $28. If we use five-year average earnings per share, the normalized P/E ratio tops a whopping 32, a significantly less attractive valuation than the one based on inflated 2021 earnings and its long-run average. Though the stock deserves a spot on your radar, the best time to buy a cyclical stock is at the bottom. It's hard, if not impossible, to time that effort precisely -- but Donnelley doesn't seem to be there yet.