One of the big challenges for average investors is sifting through the mountains of information that comes from the market on a daily basis. I think that may be the biggest reason that so many investors have learned over the course of decades of market activity to rely on analyst estimates for a company’s future prospects. As both an analyst and an investor, I actually find the idea a little be ironic, because predicting the future in any context is nothing more than pure guesswork, and any success comes by nothing but sheer luck – but we still keep trying to do it anyway.
That tendency to rely on future estimates is one of the reasons that, a long time ago I started studying the principles of value-based analysis. That process led me to the writings of Benjamin Graham, who is widely credited as the father of fundamental analysis and well-known as the man who taught a young Warren Buffett the basic principles that still drive his investment philosophy today. One of the primary takeaways for me was the way that Mr. Graham doesn’t use future estimates in his analysis. He preferred to boil his investment decision to a simple question: is the company’s book of business worth more than its stock price today? If the answer was yes, the stock was worth consideration as a long-term investment. The larger the difference between a company’s value and its actual stock price, the more compelling the argument became. Estimates about the future don’t figure into that question, or its answer, at all.
The question of how to determine the value of a company’s book of business has a lot of different possible answers. While Mr. Graham’s original data points for finding that number have become dated, the basic principles he described nearly a hundred years ago still apply, and have become the foundation of the value-based system I use to identify my own investing opportunities, and that are the core of the analysis I write about every day in this space.
Now to the stock I’m using to for today’s post. Xerox Holdings Corporation (XRX) is a company that I have followed for some time, and that I have used to pretty nice effect on a number of occasions over the last few years – even during the ongoing pandemic, when the entire Business Services industry this company operates in has struggled as practically all of corporate America has been forced to shift to remote workforce operations and the services that support them. For a business that largely relies on traditional, in-office operations, that means that XRX has been focusing extensively on cost controls to survive the worst pandemic-driven effects in order to survive.
XRX’s earnings reports for most of the past two years have indicated big impacts on their business from the COVID-19 pandemic. The stock pushed from a low around $17 in November 2020 to a high by February of that year at around $27, but from that point faded back into a consolidation range between $23 and $24.50 until September, when the stock dropped and began re-consolidating between $20 and $21. After company’s most recent earnings report, the stock took another big fall, sliding below $18 on an overnight basis. The driver for the plunge can be tied back to estimates; the company’s sales figures for the last quarter’s performance were less than analysts had predicted they would be, and management followed up by providing their estimates for quarters ahead that were also lower. The irony of those efforts to look into the crystal ball is that the company’s core fundamentals – Free Cash Flow, liquidity, debt management, and operating margins – all remain generally solid, with useful improvements over the past year in most of these areas. Does that mean that analysts and the market have overreacted? If so, that should also mean that XRX’s value profile could be even better than it was before. Let’s dive in.
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 $3.2 billion.
Earnings and Sales Growth: Over the last twelve months, earnings were flat – exactly 0%, while sales growth was slightly negative, at -0.51%. In the last quarter, earnings improved by 2.13% while revenues were -1.95% lower. These metrics can be closely tied to the market’s reaction over the last week, and the stock’s fall from grace over that period. Even so, XRX’s operating profile, which has narrowed over the last two years saw improvement; over the last twelve months, Net Income was 4.13% of Revenues, and strengthened somewhat to 5.12% in the last quarter.
Free Cash Flow: XRX’s free cash flow is healthy, at about $600 million over the last twelve months. While that number decreased from $757 million in the last quarter, it also marks a significant improvement from $474 million a year ago; given the severity of the impact the pandemic has had, the net improvement is a reasonable confirmation of the strength reflected by the increasing Net Income metric I just mentioned. The current Free Cash Flow number also translates to an attractive Free Cash Flow Yield of 18.89%. 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 until 2020.
Debt to Equity: XRX has a debt/equity ratio of .71. 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 $3.6 billion (down from $4.2 billion in the last quarter). Their balance sheet also shows more than $2.1 billion in cash and liquid assets, which means that servicing their debt isn’t a problem, and for now provides an important buffer.
Dividend: XRX pays a dividend of $1.00 per share, which translates to an annual yield of 5.62% 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 been forced to do in the last year, 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 $23 per share, suggesting that the stock is undervalued by 29% Supporting the stock’s fair value target is the fact that stock’s Book Value is $29.11 per share – which is about 68% above the stock’s current price.
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 upward trend from its low at around $17 in November of 2020 its peak, reached in February at around $27. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock’s downward trend from that high was gradual, with extended consolidation for most of this year until September. The stock really picked up bearish momentum last week, dropping below support at around $20 to a little below its current level around $18. It does appear to be trying to stabilize around its 52-week low, putting current support at around $17.50, with immediate resistance at $18.50, where the 88.6% retracement line sits. A push above $18.50 should find next resistance around $20, while a drop below $17.50 should have pretty limited downside, with the stock showing multiple pivot points in mid-2020 at around $16.50.
Near-term Keys: XRX’s value proposition is very appealing right now, and along with the company’s overall fundamental strength is a strong indication that the market is overreacting to the latest earnings announcement. That makes XRX a good candidate to consider using as a practical, value-based investment. If you prefer to use short-term trading strategies, the stock’s current levels actually make thinking about shorting the stock or buying put options a very low-probability proposition. A push above $18.50, however could provide a good signal to think about buying the stock or working with call options, with $20.50 providing a nice, quick-hit profit target, and additional upside to around $21.50 to $22 reachable beyond that if bullish momentum picks up.