Netapp: Is It a Growth or Value Stock?
Growth and value are words thrown around by some investors who don’t understand the significance of these labels. For over three decades, companies like MSCI (MSCI) have been slicing and dicing the universe of global stocks into categories like value and growth using objective measures. A stock can exist in both a growth and value index, though the total market cap weighting should always sum to 100%. Since large exchange traded funds (ETFs) track these indices, investors will gravitate towards certain companies based on their growth or value classifications. So, how does MSCI classify a stock as growth or value? Oftentimes, a stock gets classified as both.
Simply put, MSCI assigns each stock a market cap weighting of growth and value that sums to 100%. If a stock is 100% growth, then it’s only in the growth index. But if it’s 60% growth and 40% value, it’s represented in both indices. For value stocks, the classification process is quite simple. The MSCI Value and Growth Index Methodology looks at just three parameters when determining the extent to which a company should be considered a value stock:
- Book value to price ratio (BV / P)
- 12-month forward earnings to price ratio (E fwd / P )
- Dividend yield (D / P)
The last parameter is quite intuitive. When a company decides to pay a dividend, they’re effectively telling shareholders they can’t show a better return on the money internally compared to what an investor could manage. Traditionally, paying dividends is the domain of value companies, though European firms often pay dividends through periods of strong revenue growth. Today’s company, NetApp (NTAP), sounds like growth (exciting cloud computing stuff) but smells like value (dividend yield of 3%). It’s often presented as a growth company that’s enjoying the benefits of cloud computing’s explosive expansion, but the lackluster revenue growth leads us to believe otherwise.
Founded in 1992 with an IPO in 1995, NetApp offers cloud data services for management of applications and data both online and physically. We first came across the company in our piece on Pure Storage Stock: A Big Data Pure Play in which we noted they belong to a handful of major players in the flash storage arena, a thesis we wanted exposure to because of big data storage growth.
NetApp’s latest quarterly earnings saw $1.5 billion in revenues and an “all flash array annualized revenue run rate” of $2.8 billion. Back of the napkin math says that about half of NetApp’s revenues come from their flash storage offering, but that exposure isn’t growing. For whatever reason, NetApp’s flash array revenues have been declining over the past several quarters to levels they were at six quarters ago.
The flash array thesis is just one of the reasons subscribers have raised NetApp as a way we might play the growth of cloud computing, a trend that’s been growing like a weed. Consequently, any provider of solutions for cloud computing should have enjoyed decent growth over the past decade. While admittedly a newcomer, HashiCorp’s revenue chart shows consistent quarterly growth which also translates into strong annual growth.
Contrast the above chart to NetApp’s annual revenues over the past 12 years which have achieved a compound annual growth rate (CAGR) of just 1.2% while the company’s current dividend yield sits at around 3%.
So far, NetApp appears to be more value than growth, but we haven’t considered how MSCI measures growth.
Value vs Growth
MSCI’s approach to classifying growth stocks relies a lot on earnings. Three of the seven ratios used to classify growth stocks relate to earnings.
- Long-term forward earnings per share (EPS) growth rate (LT fwd EPS G)
- Short-term forward EPS growth rate (ST fwd EPS G)
- Current Internal Growth Rate (g)
- Long-term historical EPS growth trend (LT his EPS G)
- Long-term historical sales per share (SPS) growth trend (LT his SPS G)
One of the above ratios – sales per share (SPS) – is similar to our own simple valuation ratio which looks to value a company based on a ratio of their size relative to the sales they’re bringing in. NetApp has a simple valuation ratio of about two which means investors don’t see much growth in their future, all things being equal.
Typically, the faster sales are growing, the more highly the company becomes valued relative to its peers. Your ideal publicly traded disruptive tech company starts their life with sufficient traction and size which we define as follows:
- A market cap of $1 billion
- Meaningful revenues of $10 million per annum
The example above would have a simple valuation ratio of 25 and a relatively high valuation compared to our catalog average of six (we don’t presently invest in anything over 20). The small size would also indicate it’s not likely a leader (if anything, an emerging leader), so revenue growth would be critically important to ensure that they scale as quickly as possible.
What’s Acceptable Growth?
Assuming there’s a huge total addressable market (TAM) to be captured, we’d expect there to be competitors. We like to get involved only after a leader has been established, and one good proxy for “pace at which market share is being captured” would be revenue growth. Our recent piece on HashiCorp: A Play on Cloud Computing Growth showed how leading software-as-a–service (SaaS) firms are collectively lowering guidance in the face of the “challenging macroeconomic headwinds.” Only UiPath increased guidance, which is a testament to offering a solution which saves companies money (will always be in demand regardless of economic climate).
|Asset Name||Last YoY Growth||Next Year Guidance||Simple Valuation Ratio|
We typically view any double-digit growth number as acceptable, but we wouldn’t give up on DocuSign just because they have one year of 8% “forecasted” growth. Perhaps their management team is ultra conservative, and they end up clearing 20% growth (in line with what they did last year). For any of the above companies, we’ll always wait for the actual results instead of accepting guidance as truth. If a company manages 7-8% growth over a longer period of time, we find that marginally acceptable and would be attracted to such plays because they’ll typically be highly diversified. Trimble is one such example. What’s not acceptable is if growth isn’t even managing to keep up with inflation. So, we might conclude that 5% growth or lower isn’t disrupting anything. That brings us back to NetApp.
Getting Back to NetApp
NetApp’s inability to grow revenues over the past decade is a concern that isn’t alleviated by looking forward. Flash array storage represents half the company’s business, and run rate for that segment has been on the decline. Whether that’s a problem with net retention (prices or usage declining for existing clients), or gross retention (downright cancels), anybody looking for flash storage exposure would clearly opt for Pure Storage. While their revenue growth isn’t as consistent as a SaaS firm, it’s clearly trending in the right direction.
While Pure Storage blamed The Rona for a slowdown, revenue growth of 26% last year was impressive. While their revenue growth guidance for the coming year of “mid to high single digit growth” seems mediocre, let’s wait for results before rendering our verdict.
Companies with no revenues aren’t investable because they have no proven traction. Likewise, companies with no revenue growth haven’t proven they’re capable of disrupting whatever theme it is they’ve targeted. NetApp may be a firm that’s exposed to cloud computing, but it’s failing to live up to its full potential in the face of a TAM that’s expected to grow from $500 billion in 2022 to $1 trillion by 2027. While we’ve only examined the half of their business relating to storage, stagnant top-line revenue growth makes NetApp a company we’re avoiding going forward. While management probably has some master plan to resume growth, investors should chastise them for squandering one of the most illustrious bull markets mankind has seen.
Prior to covering a company, we expect there to be some revenue growth momentum that merits a further look. Sure, the snowball may have just started rolling for NetApp, but we also need to consider the macroeconomic climate. If mediocre firms couldn’t grow revenues during the last bull market which lasted over a decade, then why would we think they’d start now? When we look for companies benefiting from the growth of cloud computing, we want to see revenue growth that’s equally as exciting as the opportunity.
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