Home Gold & Precious Metals Buffett Should Be Buying Accenture – Accenture plc (NYSE:ACN)

Buffett Should Be Buying Accenture – Accenture plc (NYSE:ACN)


I will start with a quote from Warren Buffett’s letter to shareholders from the 1958 Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) annual report:

“To the extent possible, therefore, I am attempting to create my own work-outs by acquiring large positions in several undervalued securities. Such a policy should lead to the fulfillment of my earlier forecast-an above average performance in a bear market, and a normal performance in a bull market. It is on this basis that I hope to be judged.”

Judging by his compounded annual return over the 50 years from 1965 to 2015 of 21.6 percent I would have to say he and his investors are pretty happy. Consistent returns of that magnitude are getting harder to achieve but the principle is still rock solid, in my humble opinion.

I want to explain to readers how to analyze a portfolio with a focus on free cash flow return on investment rather than the often biased Wall Street recommendations. Let us begin by analyzing one of my favorite dividend growth companies, Accenture PLC (NYSE:ACN) and at the same time explain how the methodology involved in this analysis came about.

Main Street (the real world) is where Accenture operates and Wall Street (the hype casino) is where its shares trade. Accenture shares available for purchase on Wall Street are in the public domain and the company has little control over the price at which each share will trade. Accenture is required to release its earnings reports each quarter and from time to time it also provides press releases to its shareholders (and the general public) giving updates on how its operations are doing on Main Street.

Main Street is where Accenture invests in its own operations, creates products/services that its customers can purchase. How well Accenture management does in pricing and selling those products determines the profitability the company. Wall Street then reacts based on the success or failure of management to meet goals, set by analysts with guidance from Accenture management. Main Street and Wall Street thus have a seemingly symbiotic relationship. The disconnect that often occurs between the two is the result of perceptions and the ability of almost anyone to buy or sell any stock at any time. Expert analysis is not a required to invest on Wall Street. The rise of such competitive forces such as hedge funds, dark pools and HFTs (high frequency traders – using algorithms) that account for the majority of trading volume most days has created a far different investing environment from that which existed 30 or more years ago.

It seems to me that we are subject to much more of a herd mentality and momentum investing than ever before. Fundamental analysis and investing for the long-term have become unfashionable on Wall Street. That is probably because it does not produce as much revenue for the powers that be on Wall Street. They need ever-rising volumes to keep revenues and profits rising.

This results in Wall Street relying on advice coming from Wall Street to be very dangerous for individual investors. Many individual investors experience emotional swings about individual stocks and tend to follow the herd in and out creating more volume and revenue for Wall Street and often more taxable revenue for the government. During bull markets, investors experience euphoria as “the rising tide lifts all boats.” But when a bear market suddenly shows up, these same investors tend to panic and stampede over the cliff like lemmings. Thus we have the classic case of “greed vs. panic.” It is the game that Wall Street plays to its advantage, not ours.

I am a fan and student of both Benjamin Graham and Warren Buffett. Our Friedrich algorithm was designed to assist all investors (pro and novice alike) and give them the ability to quickly compare a company’s Main Street operations to its Wall Street valuation. Friedrich can do this on an individual company basis or it can assist users in analyzing an entire index like the S&P 500, an ETF, mutual fund or individual portfolio.

In reading Berkshire Hathaway’s 1986 letter to shareholders, I noticed a ratio which Mr. Buffett entitled “Owner Earnings.” It is what we would consider to be a version of “free cash flow.” This is one of the many gems hidden throughout the letters and footnotes where one can find explanations from Mr. Buffett on one of the key ratios that he and Charlie Munger used in analyzing stocks. In that footnote, he defined the term “owner earnings” as the cash that is generated by the company’s business operations.

“[Owner earnings] represent A) reported earnings plus B) depreciation, depletion, amortization, and certain other non-cash charges…less C) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume.”

I like to use this free cash flow ratio as I believe that earnings can be manipulated but a company’s ability to create cash flow is more representative of its underlying operational efficiencies and financial well-being. Arnold Bernhard, the founder of Value Line Investment Survey, was a big fan of free cash flow and probably introduced it sooner than Mr. Buffett did. Our 60-year backtest of the DJIA from 1950-2009 used data from Value Line.

In the backtest mentioned above, we demonstrated that if one can purchase a company whose shares are selling for 15 times or less its price to free cash flow ratio that the probability of success will dramatically increase in most cases. We have renamed the ratio the Bernhard Buffett Free Cash Flow ratio in honor of both men. The following is how that ratio is calculated.

Price to Bernhard Buffett Free Cash Flow Ratio = Sherlock Debt Divisor/ [(net income per share + depreciation per share) + (capital spending per diluted share)]

Sherlock Debt Divisor = Market Price Per Share – ((Working Capital – Long-Term Debt)/Diluted Shares Outstanding))

The above are the ratios to use when analyzing a stock on Wall Street and below are the ratios we use when analyzing a stock on Main Street.

FROIC means “Free Cash Flow Return on Invested Capital”

Forward Free Cash Flow = [((Net Income + Depreciation) (1+ % Revenue Growth rate)) + (Capital Spending)]

FROIC = (Forward Free Cash Flow)/ (Long-Term Debt + Shareholders’ Equity)

What the FROIC ratio does is tell us how much forward free cash flow the company is generating on Main Street relative to how much total capital it has employed. So, if a company invests $100 in total capital on Main Street and generates $20 in forward free cash flow, it therefore has a FROIC of 20%, which we consider excellent. This is just one of the key ratios (66 in total) that we use to identify how a company is performing on Main Street, as it is our belief that if a company is making a killing on Main Street, that this news will eventually show up on Wall Street’s radar.

So, let us begin our analysis and at the same time try to teach everyone how to do a similar analysis on one’s own portfolio. In analyzing Accenture’s Price to Bernhard Buffett FCF ratio we must first analyze Accenture’s Sherlock Debt Divisor. Here is a detailed definition of what that ratio is:

Sherlock Debt Divisor = A major concern that we have these days in analyzing companies is the amount of debt relative to its operating cash flow and whether management is abusing this situation by taking on more debt than it requires. Debt can be used wisely to create leverage and leverage can be extremely beneficial within certain parameters. On the other side of the coin, too much reliance on debt can be unsustainable and put a company’s future in jeopardy. So, what we have done to determine if a company’s debt policy is beneficial or abusive, is to create the Sherlock Debt Divisor.

What the Divisor does is punish companies that rely too heavily on debt and rewards those who successfully use debt as leverage. To do this we take a company’s working capital and subtract its long-term debt. If a company has a lot more working capital than long-term debt, we reward it. Conversely we punish those whose long-term debt exceeds its working capital. If the result of this calculation is higher than the current stock market price, then leverage is being employed. A company with too much leverage will generate a result of this ratio that will adjust our other ratios making the stock less attractive as an investment.

Having successfully defined the Sherlock Debt Divisor, we now need the following four bits of financial data in order to calculate it for Accenture. TTM (trailing 12 months) is about as close to real time data as we can get, based on when each company reports. Accenture last reported results in December for the quarter ended November 20, 2016 and we will use those reported numbers with the exception of the current market price.

Market Price Per Share = $122.60

Working Capital = Total Current Assets – Total Current Liabilities

Total Current Assets = $11,368,400,000

Total Current Liabilities = $9,170,100,000

Working Capital = $2,198,300,000

Long-Term Debt = $24,600,000

Diluted Shares Outstanding = 663,800,000

Sherlock Debt Divisor = Market Price Per Share – ((Working Capital – Long-Term Debt)/Diluted Shares Outstanding))

Sherlock Debt Divisor = $122.60 – (($2,198,300,000 – $24,600,000)/663,800,000))

Sherlock Debt Divisor = $122.60 – ($3.27) = $119.33

Since Accenture has less long-term debt than working capital, we reward it by using the slightly lower price of $119.33 as our new numerator in all of our calculations.

Price to Bernhard Buffett FCF Ratio = Sherlock Debt Divisor/ [(net income per share + depreciation per share) + (capital spending per diluted share)]

Sherlock Debt Divisor = $119.33

Net Income per diluted share = $4,297,500,000/663,800,000 = $6.47

Depreciation per diluted share = $734,600,000/663,800,000 = $1.01

Capital Spending per diluted share = $-486,300,000/663,800,000 = $-0.73

$6.47 + $1.01 + ($-0.73) = $6.75

Price to Bernhard Buffett Free Cash Flow Ratio = $119.33/$6.75 = 17.68

Now if one goes to our FRIEDRICH LEGEND (on what is considered a good or bad result) you will notice that our result of 17.68 is considered good.

We last ran our Datafile for Accenture on February 22, 2017, and our Friedrich Algorithm gave a recommendation to our subscribers that Accenture is a “Strong Buy” as our Friedrich Datafile and chart below show. There you will also find the last ten years of Accenture’s Price to Bernhard Buffett Free Cash Flow results.

Now that we have shown everyone how to calculate our Price to Bernhard Buffett Free Cash Flow ratio, let us now move on and explain how to calculate our FROIC ratio.

This is how we calculate it:

FROIC means “Free Cash Flow Return on Invested Capital”

Forward Free Cash Flow = [((Net Income + Depreciation) (1+ % Revenue Growth rate)) + (Capital Spending)]

FROIC = (Forward Free Cash Flow)/ (Long-Term Debt + Shareholders’ Equity)

Net Income per diluted share = $$4,297,500,000/663,800,000 = $6.47

Depreciation per diluted share = $734,600,000/663,800,000 = $1.01

Capital Spending per diluted share = 486,300,000/663,800,000 = $-0.73

Revenue Growth Rate TTM = 2%

[(($6.47+ $1.01) (1.02%)) + ($-0.73) =$6.90]

Long-Term Debt = $24,600,000

Shareholders Equity = $7,417,100,000

Diluted Shares Outstanding = 663,800,000

($24,600,000+$7,417,100,000) / 663,800,000 = $11.21

FROIC = (Forward Free Cash Flow)/ (Long-Term Debt + Shareholders’ Equity)

$6.90/$11.21 = 61.6%

FROIC = 62%

Now if one goes to our FRIEDRICH LEGEND again (on what is considered a good or bad result) you will notice that our result of 62% is an excellent result and tells us that Accenture generates $62 in forward free cash flow for every $100 it invests in total capital employed. Better yet, if we scroll back up to the datafile table, we see that Accenture has been churning out free cash flow like this for at least the last ten years. This is outstanding!

One other consideration is how a stock performs during bear markets. We include the following chart for Accenture that includes the daily closing price along with the quarterly updates from our Friedrich algorithm for overbought (shown as “sell”), fair value (labeled “Main Street Price”) and our Bargain Price.

This stock lost about 20 percent of its value in 2008 while the S&P 500 Index lost about 38 percent. It also regained its highest level of 2007 by early 2010 while the S&P 500 Index did not fully recover until early 2013. Since its peak in 2007 Accenture has risen more than 180 percent. The S&P 500 Index has risen by 50 percent over that same period. From this perspective Accenture looks to be one to buy and hold for the long term, collecting a rising dividend along the way. Current yield is just shy of two percent but it has grown at a rate of over 11 percent compounded annually over the last ten years.

Accenture is in the sweet spot of enabling governments and corporations, large or small, to adopt the newest technologies. And technology is changing at an ever increasing rate. The company has global reach with additional expansion potential into new markets. It also has room to grow through increasing market share within the markets where it already operates.

On Main Street Accenture is doing great, while on Wall Street it is far from overbought. Now, if one can build a portfolio containing similar excellent Main Street results and buy all at attractive Price to Bernhard Buffett Free Cash Flow ratio results, then your portfolio should be a star on both Main Street and Wall Street. Finding companies that have excellent results on Main Street and Wall Street (simultaneously) these days is, unfortunately, like trying to find a needle in a haystack. In order to prove this point we have analyzed the S&P 500 Index using the exact same methodology and produced final Main Street (FROIC) and Wall Street (Price to Bernhard Buffett FCF) results for the entire index.

The final results for the S&P 500 Index are:

FROIC = 12%

Price to Bernhard Buffett FCF = 38.34

For FROIC, we consider any result above 20% to be excellent and any result above 10% to be good, so the S&P 500 index in having a FROIC of 12%, can be considered good and tells us (that as a group on Main Street) the components of the index are doing well.

The problem is that Wall Street has “overbought” the index, giving it a score of 38.34 for our Price to Bernhard Buffett FCF ratio. That ratio considers a stock a bargain when it trades under 15 times and overbought when it trades over 30 times. Therefore, the S&P 500 index is some 8.34 points or about 28% in “overbought” territory.

When analyzing the table above we set up certain rules to use when analyzing any group of stocks, such as one’s own portfolio:

1) If a stock has a negative FROIC result, we automatically assign it a score of 100 for its Price to Bernhard Buffett FCF ratio, in order to keep everything consistent and logical, as you can’t have a negative Price to Bernhard Buffett FCF ratio when analyzing portfolios.

2) Then at the same time the maximum FROIC allowed is 100%, so we can keep everything consistent and logical as well, as anything higher distorts the results for the group.

3) We also give a zero result for FROIC for any “cash position” in the portfolio and a 22.50 result for the Price to Buffett Free Cash Flow, (which is 15 (buy) + 30 (sell) = 45/2 = 22.50). This was done to force one never to feel comfortable in cash, unless one has no choice in the matter, which is the case for us now. Our real time research clearly shows that the markets are overvalued, as measured by our analysis of the S&P 500 index.

Going forward, if you want to duplicate this same analysis for your own portfolio, it will require some effort on your part to calculate the FROIC and Price to Bernhard Buffett ratio for each holding. But once you have done that, you simply weigh each holding in your portfolio, multiply that weighting result by each holding’s FROIC result and then multiply each weighting by each holding’s Price to Bernhard Buffett result. Calculate the sum for each of the two columns and that will give you the final results for both ratios for your portfolio. Then you compare how your portfolio stacks up on Main Street vs. Wall Street and easily compare it to any index. For those who don’t want to do the leg work on your own we offer a service where we have done the calculations for 4000 US stocks and soon (as early as mid-year) to be 16,000 global stocks from 27 countries.

In conclusion, it is my belief that free cash flow analysis is the ultimate tool when analyzing companies, and my hope is that you may add these ratios to your own investor tool box in order to help you in your own due diligence. If you have any questions, please feel free to ask them in the comment section below and don’t forget to hit the “Follow” button next to my name at the top of this article. Now that we are able to analyze indices we will begin the process of analyzing ETFs, Mutual Funds and certain popular portfolio managers’ (gurus) portfolios in a series of articles here on Seeking Alpha. That effort will, of course, be in addition to providing analysis on individual stocks. Since most use the S&P 500 Index as the comparative benchmark, we can see how each is doing in a side-by-side comparison.

For those who would like to learn more about my investment philosophy please consider reading ” How I Created My Own Portfolio Over a Lifetime.”

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ACN over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Important Note: This article is not an investment recommendation and should not to be relied upon when making investment decisions – investors should conduct their own comprehensive research. Please read the Disclaimer at the end of this article.

Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment, tax, legal or any other advisory capacity. This is not an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice. The author explicitly disclaims any liability that may arise from the use of this material.

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