Slow and steady is rarely equated with sexy and market-trouncing returns. And that's a real shame. Companies that are able to manage modest revenue growth but superior profitability are often those overlooked gems that deliver huge investment returns.
Take FactSet Research Systems (FDS 1.06%) as an example. The financial software stock is up 17% over the past year, compared with a negative 12% return for the S&P 500. FactSet is a market beater over the past five- and 10-year periods as well -- up 148% versus the S&P 500's 59%, and 342% versus the S&P 500's 187%. The company's recent earnings release illustrates how it's pulling this off, and how it could continue to beat market returns for years to come.
Data is critical for finance
FactSet is often categorized as a financial technology company, but it's perhaps more accurate to file it under cloud software providers -- albeit one with a laser focus on the financial industry. The company's name hints at what it does. Its software helps with research and market analysis for investment managers, banks, insurance companies, and the like. And for businesses in general, FactSet also provides tools to help research industries and individual companies within them.
Though FactSet has been around for decades, its software is top-notch. For those familiar with the workings of the cloud and how critical data management is, it's notable that Snowflake (SNOW -1.99%) recently named FactSet the "2022 Financial Services Industry Partner of the Year." Snowflake said FactSet's flexibility in helping its joint customers manage and store their information is what makes it an ideal software vendor.
Because this is a veteran company, it isn't exactly high-growth. FactSet said the annual subscription value (ASV) of its software and services on an organic basis, excluding acquisitions and divestitures, grew 10% year over year in the third quarter of fiscal 2022, the three months ended in May. That's far below the growth rate of those high-flying younger peers in the fintech and cloud industries. But as a mature business, FactSet is primarily concerned with managing profitable growth, rather than growth at all costs. And this software company is especially good at generating profitable growth and returns on investment.
The synergies of software
Like many other software providers, FactSet has built itself into a type of software platform over the years -- a vendor that provides a toolset rather than a singular product to its customers. With a platform and supporting infrastructure in place, it's able to acquire smaller peers, plug them into its ecosystem, and stoke superior profitability out of them as a result.
FactSet has been a serial acquirer for years and has done an excellent job managing these integrations. It's now in the midst of putting two new prizes to work: Cobalt Software, purchased in October 2021, and CUSIP Global, purchased in December 2021. Cobalt was built for venture capital and private equity firms. It helps with portfolio monitoring and merger and acquisition opportunities. CUSIP was purchased from fellow financial data company S&P Global (SPGI -0.20%). CUSIP is the system used for identifying securities -- stocks, bonds, funds and the like -- and clearing their trade among brokers and financial institutions.
These two purchases have boosted FactSet's revenue far above that organic ASV growth of 10% reported last quarter. When factoring for the additional sales from Cobalt and CUSIP, FactSet revenue surged 22% year over year to $489 million.
But here's the beauty of bolting on new software to an existing platform. Adjusted operating income increased at an even faster rate than revenue, notching a nearly 42% year-over-year increase to $179 million -- an incredibly lucrative adjusted operating profit margin of nearly 37%. The result is a company that has historically generated large and rapidly increasing amounts of free cash flow.
Data by YCharts.
FactSet does tend to boost returns to shareholders over time through share repurchases, but for now, those are on hold until mid-fiscal 2023 or later while the company pays down debt, some of which came from those last two acquisitions. It had $527 million in cash and short-term equivalents and just shy of $2.1 billion in long-term debt as of the end of May. It's not imperative that it pay down that debt, but it's no doubt a good idea if FactSet plans to eventually make more acquisitions. But when share repurchases start again, perhaps beginning in early calendar year 2023, that will be good news for investors.
At this point, FactSet trades for a premium 30 times trailing-12-month free cash flow, and 27 times next year's expected earnings. If you're looking for a deep-value stock, this isn't it. However, given the company's long track record of growing profits at a faster pace than revenue and returning cash through share repurchases and a small dividend -- the current yield is 0.9% -- FactSet Research is absolutely worth a look for long-term investors. Expect some volatility because of the current economic environment, but FactSet could continue to be a market-beating stock over the next decade.
