Unsurprisingly, FactSet Research (NYSE:FDS) reported stellar across-the-board numbers in the first quarter of fiscal 2007, with sales up 21%, operating income up 29%, and net income up 24%. Even better, most of FactSet's growth is organic.
FactSet, along with competitors Thomson (NYSE:TOC) and Reuters (NASDAQ:RTRSY), makes a living selling financial, economic, and analytical information to financial-services firms such as Morningstar (NASDAQ:MORN). It counts 87 of the top 100 investment managers as clients -- think Legg Mason (NYSE:LM) or Franklin Resources (NYSE:BEN).
And if history is any guide at all, the big just get bigger in financial services. Just consider JPMorgan Chase and the soon-to-be Bank of New York Mellon as a pair of examples. As a provider of indispensable information to those customers, FactSet grows along with its customers in this increasingly information-hungry world. For the quarter, the company's number of net clients increased 2.5% to 1,830, but the number of users increased 4% to 31,000 -- and if a client such as Legg Mason hires more analysts, it has to pay FactSet more money for additional users. Management noted in the earnings call that the company had increased sales every quarter consecutively for a stunning 10 years.
As one would imagine, information-service businesses generally compete on scale, brand recognition, and service quality, but not on price. FactSet provides information services that are sticky and somewhat irreplaceable, resulting in a greater than 95% customer retention rate and a 32.5% operating margin. The company believes that it has locked up only 5% of the professional investment user, so growth prospects remain strong.
FactSet's strong internal growth, meanwhile, is much more conducive to producing free cash flow than is acquisitive growth, which requires a significant -- and often value-destroying -- cash outlay. The company's organic growth helped it generate $15 million in free cash flow for the quarter, up 41% from the prior year's matching period.
This is a gem of a company. Unfortunately, it's also priced like one. I'm not saying FactSet shares are overpriced, but as a value investor, I look for gems that look like lumps of coal. I already use FactSet's services; if its shares ever trade at a more attractive valuation, I hope to enjoy its organic growth as both a customer and a shareholder.
Here's some other insightful commentary on FactSet:
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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above and Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.
