Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does SolarWinds (NYSE: SWI) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.
What we're looking for
The graphs you're about to see tell SolarWinds's story, and we'll be grading the quality of that story in several ways:
- Growth: Are profits, margins, and free cash flow all increasing?
- Valuation: Is share price growing in line with earnings per share?
- Opportunities: Is return on equity increasing while debt to equity declines?
- Dividends: Are dividends consistently growing in a sustainable way?
What the numbers tell you
Now, let's take a look at SolarWinds's key statistics:
SWI Total Return Price data by YCharts.
|
Criteria |
3-Year* Change |
Grade |
|---|---|---|
|
Revenue growth > 30% |
118.8% |
Pass |
|
Improving profit margin |
21.9% |
Pass |
|
Free cash flow growth > Net income growth |
164.1% vs. 166.6% |
Fail |
|
Improving EPS |
162.5% |
Pass |
|
Stock growth (+ 15%) < EPS growth |
127.6% vs. 162.5% |
Pass |
Source: YCharts. *Period begins at end of Q2 2010.
SWI Return on Equity data by YCharts.
|
Criteria |
3-Year* Change |
Grade |
|---|---|---|
|
Improving return on equity |
(32.3%) |
Fail |
|
Declining debt to equity |
No debt |
Pass |
Source: YCharts. *Period begins at end of Q2 2010.
How we got here and where we're going
SolarWinds comes through with flying colors, earning five out of seven possible passing grades, narrowly missing a sixth pass only because its net income has nudged ahead of free cash flow during our tracked period. However, the raw numbers reveal that SolarWinds' free cash flow has remained higher than its net income over the past three years. This is an impressive performance, but can SolarWinds keep up the progress and possibly reverse the slide in its return on equity metric? Let's dig a little deeper to find out.
Recently, SolarWinds' shares plunged more than 23% the day after it reported second-quarter earnings. The company's revenue, despite rising 21% year over year, fell short of high analyst expectations. Fool contributor Travis Hoium has pointed out the sluggish growth in its licensing business appears to be the main pressure point causing SolarWinds so much pain.
Earlier this year, SolarWinds investors reacted almost as poorly to a non-earnings announcement: The company is set to acquire cloud-based infrastructure developer N-able for $120 million. One analyst predicted a rather sizable hit to this year's earnings as a result of the buy. Between this drop and the more recent earnings plunge, SolarWinds is certainly proving Fool contributor Sean Williams right in his prediction of underperformance. Since Sean called SolarWinds a sell in February, its stock has lost a third of its value!
SolarWinds has never been "cheap" on a valuation basis in its relatively short public life, but right now, the company sports one of the lowest P/Es it's ever had. Its price-to-free cash flow ratio is even lower -- compared to its 31 P/E, its 18.5 price-to-free cash flow ratio is practically a bargain. If the company's future fundamental growth rates look anything like its history, this might be one of the best times to be a SolarWinds shareholder.
Putting the pieces together
Today, SolarWinds has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.
