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A Wish List for 2020

Over the last couple of years, there have always been some high-quality businesses that we cannot own enough of at Urbem. They typically earn a superior return on capital, are protected by a wide and deep economic moat and possess one or more secular growth engines. More often than not, the only obstacle preventing us from buying more shares is the price. This is especially a painful case for us as the market continues its historic bull run.


Below is our wish list of stocks that we would buy a lot of should the valuation become at least reasonable (not necessarily attractive) in 2020. With patience, we keep our fingers crossed and hope for good deals from Mr. Market this year.

SimCorp

Denmark-based SimCorp (OCSE:SIM) provides integrated software solutions for the buy-side industry worldwide to enhance efficiency, ensure regulatory compliance and save costs. The business generated an over 60% return on equity and almost 50% on invested capital for the trailing 12 months. We believe that the switching cost of SimCorp's mission-critical software builds the economic moat for the business to sustain its industry-beating returns. At the same time, the company should have plenty of opportunities to reinvest its residual cash, as the asset management industry continues to experience technology upgrades and focus on operational efficiency.

On the valuation side, however, we notice that the share is currently changing hands at a price to free cash flow rate of almost 45 times, which, in our opinion, has already priced in most (if not all) of the growth potential.

MasterCard

New York-based MasterCard (MA) operates one of the world's largest and fastest payment processing networks, connecting consumers, financial institutions, merchants, governments and businesses in more than 210 countries and territories. Over the trailing 12 months, the company earned a more than 100% return on equity and more than 50% on invested capital, protected by a competitive moat through a world-class brand, scale advantage and a two-sided network effect. With a massive base of underserved cash/check consumers worldwide, MasterCard should see its secular growth continue for the foreseeable future.

With regards to valuation, however, the stock is currently traded at over 50 times price to free cash flow, reflecting a yield of less than 2%. As you can see below, the price multiple steadily trended up for the last couple of years.

Hermes (XPAR:RMS)

France luxury brand Hermes (XPAR:RMS) designs and manufactures goods such as leather products, saddlery, accessories, silk, textiles and perfumes. In our view, the century-old company has a wide and deep moat in the form of its famous ultra-luxury brand name, which not only fends off competition but also immunizes the business from economic downturns. The firm earned a 27% return on equity for the trailing twelve months.

Despite the quality of the business, the share looks unreasonably expensive, with a price to free cash flow ratio of more than 50. Looking at the past decade, we seldom find an entry point with a more than 3% free cash flow yield for the stock like this one(see below), but it appears that a bit more patience is required here.

Technology One

Australia-based Technology One (ASX:TNE) is an enterprise software supplier of comprehensive, deeply integrated solutions. which it mainly sells to the government, financial services, health and community services, education and utility sectors. For the trailing 12 months, the business earned an over 40% return on both equity and invested capital. A high switching cost, as well as a local reputation and insight, build the competitive moat at Technology One. Benefiting from the megatrend of increasing digitization and automation among enterprises, the company is heavily investing in research and development to extend its SaaS offerings further.

An attractive business does not necessarily lead to an attractive stock. As shown below, the valuation of Technology One steadily climbed over the last decade. The current cash flow yield is less than 1.5%. While the management is targeting a 148% total increase in annual recurring revenue by 2024, we feel that Mr. Market is way over-excited at the moment.

Rollins

Atlanta, Georgia-based Rollins (ROL) is the premier provider of pest and termite control and related services for millions of household and commercial customers around the world. Over the trailing 12 months, the business earned a 26% return on equity. We think that the moat around Rollins mainly comes from its brand, scale and single-industry focus. The reputation for quality and safety and customer proximity are both critical factors for business success in the pest control industry. Moving forward, we notice a highly fragmented market, presenting massive consolidation potential for Rollins to fuel its long-term growth.

The stock of Rollins hasn't looked cheap since 2016. The current price to free cash flow ratio is 39, the lowest among all names on our 2020 wish list. As you may notice below, the valuation went down by almost 40% since the recent peak in 2018. Although no one can predict Mr. Market, we are more than happy to see the trend to continue even as a shareholder.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the financial market. We own shares of SimCorp, MasterCard, Technology One, Hermes, and Rollins.

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This article first appeared on GuruFocus.