It’s been a little over 41 months since I wrote my upbeat article on F5 Networks Inc. (NASDAQ: FFIV), and meanwhile, stocks have returned about 25% versus a gain of about 64% for the S&P 500. I thought I’d check on the the business again to see if it makes sense to buy more, hold or sell. I’m going to make this decision by reviewing recent financial history here and considering the stock as something separate from the underlying business. Also, I’ve written put options on this stock before, and that requires comment as well.
You have dummies to date, shipwrecks to explore, and new frontiers of science to unlock. For my part, I have a lot of “Days of our life” to catch up. We are all busy and live rich and fulfilling lives. For this reason, I want to save you as much time as possible by giving you the highlights of this paragraph, the “thesis statement” paragraph. I am of the opinion that for a business to be “growing”, profits must grow along with sales. When it’s not, I worry. This does not disqualify the action, however, unless the rating is “out of kilter”. Unfortunately, the valuation is currently “out of kilter”, so I am forced to withdraw my chips from this particular table. The combination of slow earnings growth and a very rich valuation is too much for me. I would also like to point out that the last time stocks traded at current valuations, they continued to perform poorly. Normally in these circumstances I like to compromise and sell put options at reasonable strike prices, but the stocks are so much higher than I would be willing to pay that the premiums don’t justify the effort.
I characterized this company as a “growth” company the last time I reviewed it, and in some ways that perspective is valid. For example, the company grew its revenue by just under 11% in 2021 compared to 2020. The same could be said if we compare the most recent quarter to the same period last year. Revenues are 10% higher than in 2020 and just under 21% higher than they were during the same period in 2019. The problem is that expenses are increasing at the same time as sales.
For example, from the year 2020 to 2021, sales and marketing, R&D and G&A expenses are higher by 8.6%, 10.3% and 16% respectively. To put that in dollars, while revenue grew by $252 million from 2020 to 2021, those three expenses grew by $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 urge to remind some of my tech investor friends that we are compensated with what’s left over after the company has paid staff, suppliers, taxes, interest, etc. . So, sales growth is fine, but we owners need to worry only about profit growth.
Just because I consider this company relatively troubled doesn’t mean I’m not comfortable increasing my position here. After all, the cloud and internet security remain buoyant sectors, and the company is profitable. Additionally, in 2021, it acquired compelling businesses (Volterra and Threat Stack), and these could significantly improve profitability. So it’s time to consider stock as something separate from the business. If the stocks are cheap enough, I’d be happy to buy.
I have to consider the action as something separate from the underlying business because the business is selling internet security solutions. The stock price, on the other hand, 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’ll emphasize this point using F5 itself as an example. The company released its latest results on February 4. If someone had bought that day, it would have gone up about 2% since then. If they had waited three weeks, they would have fallen about 3.7%. Not enough happened in the underlying company to warrant nearly a 6% change in returns in three weeks, so the investment was either “good” or “bad” depending on whether you have bought or not on a day when the mood was more pessimistic. That’s why I only want to buy stocks that are cheap relative to their own history and the broader market.
With all of this preamble, in my previous article on this name, I gushed that the stock was trading at a price to free cash flow of about 14.6 times. Stocks are now about 56% more expensive according to the following criteria:
Although history does not repeat itself, it certainly “rhymes” in my experience. Stocks are near a multi-year high valuation, and the last time they hit those levels they continued to perform poorly. This is enough for me to sell my shares at this point. There is more and more evidence that profits are not keeping up with sales, and the market is now much more bullish, and that is never good in my opinion.
In my previous article, I recommended selling January 2019 puts with a strike price of $155 for $3.80. These expired worthless, which was a nice result at the time. Because I’m the type to repeat the same point over and over again, I’m going to do it again. I consider it “win-win” transactions when I earn decent bonuses for strike prices that I would be willing to pay. If the stock stays above the wonderful strike price, the put options expire worthless and the whiskey buyout fund grows a bit. If the stock price goes down, I will be forced to buy, but I will do so at a price that I have determined to be very good.
Although I normally like to try to repeat success, the stock price is so much above strike prices that I would be willing to trade, that I cannot. For example, July 155 put options are currently offered at $0, which is understandable given that this strike price is about 25% below the current market price. Because of this, I’m forced to sit back and wait for the stock to drop to a more reasonable level before I consider buying back.
In my opinion, for a company to be considered a “growth” company, profits must grow along with sales. That’s not the case in this case, and that bothers me. This lack of earnings growth may be one reason for the stock’s underperformance since I acquired it, but I’m now ‘out’. I’m selling today and will buy back if valuations come back to something reasonable. This is because if the stock price goes down, I will also sell put options on the name. I am of the opinion that “price” and “value” are separate things, and they can remain disconnected for a long time. In my opinion, investors would be wise to sell before the price drops to better match the value here.