FactSet A Great Company And Questionable Stock

By Ryan C. Fuhrmann | December 17, 2010 AAA

FactSet Research Systems (NYSE:FDS) sells financial software and related systems that help investment professionals research and trade securities. It has developed a stellar reputation in the industry, and is considered a must-have product to many individuals in the financial industry. And though the company is appealing, its stock is less so.
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First Quarter Review
Total revenues increased 11.6% to $173.3 million. U.S. revenue accounted for just over 68% of total sales and grew 12%. The rest consisted of international revenue, which grew 10%. Buy-side clients, including money managers such as Legg Mason (NYSE:LM) and Federated Investors (NYSE:FII), made up 82% of the top line, with sell-side clients such as Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS), making up the rest.

Operating expenses rose 12.5% to outpace sales growth. This tempered the operating income increase to 10%, but at $59.4 million it represented a very healthy 34.3% of sales and demonstrates just how profitable FactSet's business is. Lower income taxes boosted net income growth to 15.1% as the bottom line reached $41.6 million, or 24% of sales. Share buybacks boosted per-share earnings by 18.9% to 88 cents per share. This came in ahead of analyst expectations.

Outlook
Management provided second-quarter guidance and said to expect sales between $174 million and $179 million with earnings in a range of 85- 87 cents per share. For the full year, analysts project sales growth of just over 11% and total sales of just over $714 million. The earnings consensus figure is $3.51, which would represent year-over-year growth of approximately 9%.

The Bottom Line
In addition to the impressive profit margins FactSet posts, it also generates lots of free cash flow. Last year, it generated $190.3 million in free cash, or almost $4 per share. The company is also growing rapidly and has increased sales and earnings at more than 30% annually over the past five years. This is especially impressive given the financial crisis has put many of its core customers in shaky financial positions and less able to afford financial products. It also has no debt, so it is financially sound.

FactSet's stability speaks to the fact that its clients consider its systems a must-have, no matter the economic climate. Investors have taken notice of this fact and its stellar growth in recent years, and this has led to a lofty valuation of more than 26-times forward earnings and nearly 23-times trailing free cash flow. Investors that expect growth to continue apace may be interested in paying up for the stock. For others, the high price leaves too little downside protection should growth fail up to live up to past trends. (To learn more, see Free Cash Flow: Free, But Not Always Easy.)

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