Don't Buy This Stock Because It Lacks Growth

Vladimir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Despite the rise of the stock market this year, the demand for financial information seems to be stalled, and the latest earnings report from FactSet Research Systems (NYSE: FDS) has confirmed this statement. The provider of financial information for portfolio managers and research professionals has reported that its revenue has grown a modest 6% year-over-year, while its earnings grew 10%. The company's stock is up 13% this year, but it has lacked direction for a long period of time and has been trading back and forth in a range. Is there enough momentum to push the stock to new heights?

Challenging present

FactSet clients can be divided into two groups: buy-side and sell-side. The buy-side represents funds that manage their portfolios, while the sell-side represents brokers who produce research for their clients. FactSet states that buy-side clients have been adding users in the last quarter, while sell-side clients, particularly equity research clients, have been reducing their users.

The outlook for the growth of financial information products remains foggy. Thomson Reuters (NYSE: TRI), which has financial information products among its offerings, has seen its financial & risk revenues drop 3% in the most recent quarter. Morningstar (NASDAQ: MORN), who's financial information products target a wider audience, has seen its revenue rise a modest 5% in the last quarter. These results are not particularly impressive.

Can FactSet grow?

What is the reason behind the lack of growth? FactSet's products are expensive. In fact, when reporting clients, FactSet does not include clients that pay less than $24,000 a year. Companies in all industries are getting increasingly worried about costs. This year is the first year out of five when the equity funds get a net inflow of money, so it's no wonder they are cautious about paying. Retail investors are still in doubt about the market prospects. The financial crisis has done its damage, and while the S&P 500 has reached pre-crisis levels, the confidence of retail investors has not.

What must happen for this trend to change? First, we need to see more inflow into equity funds. This would boost the need for in-house research. Retail investor confidence must improve to increase the need for sell-side research. For FactSet, buy-side clients are more important because they bring 83% of total revenues. The improvements on this front would also benefit Thomson Reuters. Morningstar needs the return of the retail investor.

Positive side

FactSet has a very high retention rate of 92%. Clients stay with the company. There are two main reasons for this. First, FactSet's products, as well as other financial information products, are complex enough. It means that switching is not easy. The second reason is that FactSet offers good quality and its users are satisfied.

The company has increased its dividend from $0.31 to $0.35 per share. At current prices, it yields 1.42%. The company has also increased its share repurchase program, with $206 million authorized for share repurchases.

FactSet trades at 19.4 forward price-to-earnings ratio. It also operates at a healthy 33.4% margin. Thomson Reuters trades at 15.75 forward price-to-earnings ratio and operates at a 20% margin, while Morningstar trades at 24 forward price-to-earnings ratio and operates at a 24% margin. The group looks fairly priced, though Moringstar's shares may have gotten ahead of themselves.

Industry comparisons

Thomson Reuters is interesting from an income perspective. The company's stock yields an impressive 4.10%. On the other hand, the company has a relatively high debt-to-equity ratio of 0.45. With the company's stable cash flow from various business segments, however, it seems to handle it well. 

Morningstar's 0.67% dividend is not something you would look for. With the current state of the economy, retail investors are not fully back in the market. Recent market action adds to overall anxiety, something that is not favorable for Morningstar's growth prospects. The company is a well-run business, but I see limited upside for the stock while the risks are significant.

Bottom line

FactSet has a solid business, but you need more than just solid business for a good stock growth. At the present, I do not see any growth points that could substantially move the stock. It is reasonably valued when compared to peers. The demand for financial information is stable, but not soaring. I think that FactSet will continue to trade in the same range where it is currently trading for more than a year.

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends FactSet Research Systems and Morningstar. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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