Investment pros will finally admit it when you pin them down: Short-term stock movements are about luck. We can speculate about what the Federal Reserve will say at the next meeting, how soon and how fast inflation will slow, or when the war in Ukraine will mercifully end, but no one really knows. Successful investing isn't about chasing short-term fads; it's about looking at secular trends and choosing terrific companies that will profit.
As Wayne Gretzky said (and Warren Buffett and Steve Jobs have quoted), "Skate to where the puck is going, not where it has been."
1. Palo Alto Networks leads a growing industry
Cybersecurity is top of mind for businesses, governments, infrastructure heads, and even school districts. At the same time, the threats are constantly evolving, and Palo Alto is also transforming. A few years ago, Palo Alto was primarily a Next-Gen Firewall product company. Management saw where the puck was going (into the cloud), and now they have sophisticated solutions for cloud and network security as well as security operations.
This is vital because subscription revenue is consistent and reliable. Subscription and support reached 75% of total sales in fiscal 2022, up from 69% in fiscal 2020. Revenue growth is also accelerating, from 18% in fiscal 2020 to 29% in fiscal 2022, and the remaining performance obligation (revenue to be recognized in future periods) skyrocketed to $8.2 billion on 40% growth.
Palo Alto is executing remarkably well, and the proof is in the cash flow. The chart below shows the recent rise in free cash flow and free cash flow per share.
The stock price-to-free-cash-flow ratio is now 25% below its five-year average, as shown below.
Statista estimates that global cybersecurity revenue will grow from $156 billion to $262 billion in five years. Palo Alto is built to grow, evolve, and profit from these expanding cybersecurity needs.
2. Builders FirstSource: Profit from secular housing demand
Much has been made about a short-term slowdown in housing demand as interest rates rise from historic lows. But this snapshot doesn't tell the whole story. The chart below shows how severely underbuilt U.S. housing has been since the Great Recession, which resulted in a shortage of 2 million to 6 million homes.
Meanwhile, the U.S. population is growing. Builders FirstSource seeks to be the premier building supplier in the nation and it recently acquired more than a dozen regional operations in high-growth localities. The increased efficiencies are paying off as operating income climbed to $3.2 billion through third-quarter 2022, a stark increase from $1.8 billion the prior year. Free cash flow is expected to skyrocket from $286 million in 2020 to $3.2 billion in 2022.
Much of its success and opportunity lies with value-added products. Far from being just a lumber yard, Builders FirstSource provides manufactured specialty products and services, and windows, doors, and millwork. Value-added products accounted for an impressive 48% of sales last quarter.
The housing market could slow as people adjust to normalized interest rates. However, Builders FirstSource's stock buyback program will support shareholders in the meantime. The company added another $1 billion (more than 10% of the market cap) to the program, which has repurchased $3.8 billion of shares since 2021. Builders FirstSource could richly reward shareholders over the long haul.
3. Texas Instruments is assembled to win
The recent CHIPS Act signed by President Joe Biden highlights the need to compete with China in the semiconductor market by incentivizing companies to assemble them in the U.S. There is also fear that companies reliant upon manufacturing in Taiwan could be devastated by a hostile Chinese takeover. While some companies may scramble, Texas Instruments is far ahead of the curve.
Texas Instruments has fabricating and assembly locations in the U.S. and other friendly nations like Japan, the Philippines, and Malaysia. Further cutting the risk, it can source 75% of its products from multiple sites.
Semiconductor needs surge across industries, and Texas Instruments has a strong foothold in industrial (41% of sales), automotive (21% of sales), and personal electronics (24% of sales). Its diverse revenue stream includes 80,000 products and 100,000 customers.
Investors in Texas Instruments know they are getting top-notch cash management. The dividend, currently yielding just under 3%, has grown for 19 straight years at 25% compounded annually, while buybacks have reduced the share count by 46%. The company ranked in the 87th percentile in cash returns among S&P 500 companies in 2021.
Successful investors look beyond the current headlines to identify long-term winners. The companies above reside in secular growth industries and display prowess that could reward shareholders for years.