No matter what your investing philosophy is, or how you go about identifying stocks in which to consider putting your money to work, one of the most basic questions you have to ask yourself if whether the potential opportunity outweighs the opposite potential for loss. I like to call that portion of my system reward: risk analysis. How much reward is required for the risk you might need to accept in an investment depends largely on the investing style of method you’re using. For short-term trading strategies like swing or momentum trading methods, I like to use a minimum threshold of 2:1, meaning that the potential reward has to outweigh the risk by at least double.
Longer-term investing methods, like value investing, are a little harder to pin down in the same way. That’s because the basic premise behind value investing doesn’t really factor near-term risk into an investing decision’s question. If a stock is currently priced at a significant discount to what your analysis indicates the intrinsic value of the core business is, short-term risk is usually dismissed in favor of the long-term outlook. What that doesn’t eliminate, or even try to make easier, is the emotional weight of watching a stock drop significantly below the price you bought it at. A pure value investing model simply assumes that you’re in for the long haul and are willing to ride out any short-term dips or troughs in a stock’s price, no matter how dramatic or steep they may be.
One of the things I like about value investing is the way that it naturally gravitates to stocks that are generally already at or near historical low prices. Under normal circumstances, that usually means that the downside risk aspect is minimized simply because the market is usually more likely to push a stock higher out of those extreme lows once investors begin to recognize the value proposition is in place. That typically means my reward: risk analysis is easier to skew in my favor – especially if the underlying business is healthy.
A secondary factor that I like to consider in my value analysis is the direction of a stock’s trend. An extended, long-term downward trend is pretty typical for stocks trading at bargain prices, which means that in many ways, value investing works in a contrarian fashion to traditional market opinion. There is a nice intersection of two, however, that can also be seen if a stock offers a terrific value proposition, along with indications that its trend is about to reverse to the upside. That could include short-term rallies and price patterns that generally signal more upside on the horizon.
One of the companies that I think offers an interesting case in point right now is Xerox Holdings Corporation (XRX). This is a company whose business is built around digital printing technology and workplace solutions. The last couple of earnings reports for this company have indicated big impacts on their business from the COVID-19 pandemic; those setbacks have been strong enough to prompt the company to suspend forward guidance for revenue and profitability growth for the time being. The stock has been holding for most of the last few months in a narrow trading range below $20, but since the beginning of this month has begun to pick some bullish momentum. Despite the pandemic’s impact over the last few months, the company’s balance sheet remains strong, which implies that they are well-positioned to ride through the economic turmoil of current conditions and come out ahead in the long run.
Fundamental and Value Profile
Xerox Corporation is a provider of digital print technology and related solutions. The Company has capabilities in imaging and printing, data analytics, and the development of secure and automated solutions to help customers improve productivity. The Company’s primary offerings span three main areas: Managed Document Services, Workplace Solutions and Graphic Communications. Its Managed Document Services offerings help customers, ranging from small businesses to global enterprises, optimize their printing and related document workflow and business processes. Managed Document Services includes the document outsourcing business, as well as a set of communication and marketing solutions. The Company’s Workplace Solutions and Graphic Communications products and solutions support the work processes of its customers by providing them with printing and communications infrastructure. XRX’s current market cap is about $4 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined nearly -85%, while sales decreased by -36%. In the last quarter, the decline in earnings accelerated to -28.57% while revenues were -21.24% lower. XRX’s operating profile before the pandemic set in was very healthy; over the last twelve months, Net Income was a little over 13% of Revenues; however in the last quarter, this metric narrowed significantly to 1.84%. It’s worth noting that in the quarter prior, quarterly Net Income was -0.11% – which means that the new quarterly number marks an improvement that could signal the company has managed to absorb the worst and is already turning the corner. Even so, this measurement remains a red flag that bears monitoring in the quarters ahead.
Free Cash Flow: XRX’s free cash flow is healthy, at about $775 million over the last twelve month. That number did drop from a little more than $1.2 billion in the quarter prior; but given the severity of the impact the pandemic has had, the turn isn’t surprising. The current Free Cash Flow number still translates to an attractive Free Cash Flow Yield of more than 19.39%. It is also worth noting that XRX’s Free Cash Flow was $0 in June of 2018, with the company showing consistent improvement in this critical metric from that point. That acts as an interesting counterpoint to the company’s Net Income story, however it also bears watching in quarters ahead to determine if Free Cash Flow deteriorates further, or follows the Net Income pattern to start moving back higher.
Debt to Equity: XRX has a debt/equity ratio of .40. That’s generally a conservative number that reflects management’s approach to debt management. Since the beginning of 2018, the company’s long-term debt has decreased from a little more than $5.2 billion to its current level of $2.1 billion. Their balance sheet also shows more than $2.27 billion in cash and liquid assets, which means that servicing their debt isn’t a problem, and provides an important buffer, even if Net Income and Free Cash Flow remain challenged. It should also be noted that in the last quarter, long-term debt dropped was $3.2 billion – meaning that even as the company grappled with the complications of pandemic-induced slowdowns, it managed to pay down almost $1 billion of long-term debt.
Dividend: XRX pays a dividend of $1.00 per share, which translates to an annual yield of 5.29% at the stock’s current price. As things stand now, the dividend appears stable; it could also provide signals of fundamental weakness or strength, depending on whether management chooses to leave it as is, or as some companies have already started doing, decides to reduce or even eliminate it to save cash.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to worth with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term target at about $24.50 per share. That suggests the stock is significantly undervalued, by more than 30% right now.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s downward plunge from its high at around $39.50 in November to the stock’s low point, reached in mid-May at around $15. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The greatest portion of that drop came in one month, from February to March, with the broad market’s nosedive into bear market territory. While the broad market indices have rebounded since then, the stock has languished until recently, hovering in a narrowing range between support at $15 and resistance at around $18. Since the end of July, the stock started picking up bullish momentum, breaking above $18 about a week ago and finding a new recent high at around $19.50. A bounce off of new support at around $18 (prior resistance becomes new support) would be a good indication the stock should break resistance at $19.50 and push even higher, with upside to nearly $24 where the 38.2% retracement rests at minimum. A drop back below $18 should see the stock test its prior support at around $15.
Near-term Keys: XRX has a very attractive value proposition, and some intriguing fundamental strengths as reflected by its current balance sheet that I think make it a useful stock for value investors. An improvement in Net Income on a quarterly basis, with continued stability in Free Cash Flow, cash, and long-term debt levels would be a good sign that the last quarter was just a one-time anomaly for a company with an overall solid fundamental profile. If you prefer to work with short-term trading strategies, the stock’s recent rally could offer some interesting opportunities. Take a pivot low off of support around $18 as a signal to buy the stock or work with call options, with a near-term price target at around $24. If the stock drops below $18, consider shorting the stock or buying put options, using $15 as a quick-hit profit target on a bearish trade.