It’s been just over 41 months since I wrote my upbeat article on F5 Networks Inc. (NASDAQ: FFIV), and in that time, the stock has returned about 25% vs. a ~64% gain for the S&P 500. Thought I’d check the company again to see if it makes sense to buy more, hold or sell. I’ll make that determination by looking at the recent financial history here, and looking at the stock as something other than the underlying business. Also, I’ve sold puts on this stock before, and that calls for comment as well.
You have supermodels to date, shipwrecks to explore, and new frontiers of science to unlock. For my part, I have plenty of “Days of Our Lives” to catch up on. We are all busy and live rich and fulfilling lives. For that reason, I want to save you as much time as possible by giving you the highlights in this “thesis statement” paragraph. I am of the opinion that for something to be a “growth” company, profits have to grow along with sales. When that doesn’t happen, I worry. However, that does not disqualify the stock from consideration, unless the valuation gets “out of control.” Unfortunately, valuation is currently “out of control” so I am forced to withdraw my chips from this particular table. The combination of slowing earnings growth and a very rich valuation is too much for me. I’d also like to point out that the last time shares traded at current valuations, they underperformed. Normally, in these circumstances, I like to commit and sell puts at reasonable strike prices, but the stock is so far above what I’d be willing to pay that the premiums aren’t worth the effort.
I characterized this company as a “growth” company the last time I reviewed it, and in a way, that perspective holds up. For example, the company increased revenue by just under 11% in 2021 relative to 2020. The same could be said when comparing the most recent quarter to the same period last year. Revenue is 10% higher than in 2020 and just under 21% higher than during the same period in 2019. The problem is that expenses are growing along with sales.
For example, from the full year 2020 to 2021, Sales and Marketing, R&D, and G&A expenses increased by 8.6%, 10.3%, and 16%, respectively. To put this in dollar terms, while revenue was up $252 million from 2020 to 2021, these three expenses were up $325 million. This is a problem for me, and I would need to see sales growth outpacing cost growth to stay excited.
It’s at this point that I feel a sudden need to remind some of my tech investor friends that they compensate us with what’s left over after the company pays staff, vendors, taxes, interest, and the like. So sales growth is all very well, but as owners we only need to worry about earnings growth.
Just because I think this company is in trouble doesn’t mean I don’t feel comfortable expanding my position here. After all, cloud and Internet security are still growth sectors and the company is profitable. Also, in 2021 it acquired some attractive businesses (Volterra and Threat Stack), and those can dramatically improve profitability. So, it’s time to consider stocks as something other than business. If the shares are cheap enough, I’d be happy to buy.
I have to treat the stock as something other than the underlying business, because the business is selling Internet security solutions. Meanwhile, the share price is a reflection of the mood of the crowd about a given entity. The crowd seems to change their minds very quickly, which is why the stock price has been so choppy over time. I will highlight this point using F5 as an example. The company reported its latest earnings on February 4. If someone had bought that day, it would have been up 2% since then. If they had waited three weeks, they would have dropped 3.7%. Not enough happened in the underlying company to justify a return change of close to 6% in three weeks, so the investment was “good” or “bad” depending only on whether or not you bought on a day when the state of mood was good. more pessimistic. That’s why I only want to buy stocks that are cheap relative to their own history and to the market in general.
With all that as a preamble, in my previous article on this name, I got excited about the fact that the stock was trading at a free cash flow price of ~14.6x. Stocks are now 56% more expensive based on the following:
While history doesn’t repeat itself, it certainly “rhymes” in my experience. Stocks are near a multi-year high valuation, and the last time they hit these levels, they underperformed. That’s enough to sell my stock right now. There is increasing evidence that earnings are not keeping up with sales, and the market is now much more bullish, and that is never a good thing in my opinion.
In my previous article, I recommended selling the January 2019 put options with a strike price of $155 for $3.80. These expired worthless, which was a nice result at the time. Since I’m the type to repeat the same point over and over again, I’m going to do it again. I consider these to be “win-win” trades when I earn decent premiums for strike prices that I would be willing to pay. If the shares remain above the excellent strike price, the put options expire worthless and the whiskey buyout fund expands a bit. If the stock goes down in price, I will be forced to buy, but I will do so at a price that I have determined to be very good.
While I usually like to try to repeat the success, the stock price is so far above strike prices that I would be willing to trade that I can’t. For example, the July 155 put options are currently being bid at $0, which is understandable given that that strike price is about 25% lower than the current market price. For that reason, I am forced to sit back and wait for the stock to drop to a more reasonable level before considering buying again.
In my opinion, for something to qualify as a “growth” company, profits must grow along with sales. That’s not happening in this case, and that presents a difficulty for me. This lack of earnings growth may be one reason the stock has underperformed since I bought it, but now I’m “out.” I am selling today and will buy again if valuations are reasonable again. In fact, if the stock goes down in price, I’ll also sell some puts on the name. I am of the opinion that “price” and “value” are different things and can remain disconnected for a long time. In my opinion, investors would do well to sell before the price drops to further match the value here.