Preliminary Prospects Series #1
A review of some companies I'm keeping an eye on but not yet buying
Dear Readers,
As I mentioned last time, I’m excited to start a new series called the Preliminary Prospect Series for the newsletter. The plan here is to review a batch of companies in a single post. These are companies I consider great prospects but fall slightly short. Either the current price is not sufficiently cheap, the future cash flow is too uncertain, or the balance sheet is just a bit too shaky. The risk/reward profile is just not quite good enough at the current moment.
Regularly reviewing these helps us to maintain the extreme rigor required to keep focus on our concentrated investment strategy of retaining only the most promising investments.
After all, any newsletter that promises you 5 new amazing investments every post is just giving you 5 mediocre investments every post.
With all that being said, these companies are still very interesting. For one, many of them are amazing investments just waiting for the right entry price. In addition, why we choose not to invest is just as instructive as why we do. While many people will write about the later, I don’t think enough attention is given to the former. This series gives us a chance to focus on that a bit more.
In this first post of the series, we review 5 companies. The first 2 are broadly accessible while paid subscribers can access all 5. Thank you again for your support and consider becoming a paid subscriber if you enjoy this material.
Global Valuation Assumption: For all DCF valuations below, we assume 9% discount rate and 4% long term FCF growth rate after year 6.
Stock #1 Workday (WDAY)
Ever had to pull your W-2, check a recent raise, or annual bonus at work? There’s a chance you may have used Workday.
Workday, Inc. WDAY 0.00%↑ is a cloud-based enterprise software company. These companies basically make software solutions for other businesses. In Workday’s case they started off primarily creating solutions for human resources (HR). The more technical term for this is Human Capital Management (HCM) which includes things like payroll and workforce management. If you’ve worked at a company that uses Workday, chances are very high that you’ve had to interact with their system and those who are in management end up using it quite a bit. They’ve been working on expanding out of this core competency since 2016 and moved into the finance area as well.
I really like the enterprise software industry as they naturally have Switching Cost Power. If you’re not sure what that is, take a look at my recent post on Review of 7 Powers. This is reflected in a substantial portion of revenue being broken up as “recurring revenue” or “subscription revenue”. Workday has also begun generating positive profit in 2024 which illustrates that they’ve proven their business model. Timing wise, this is when I like to invest in companies like this.
The company is worth watching but I would ideally like a better entry point. The stock-based compensation is still quite high for at around $1.5 billion per year relative to their free cash flow of only a bit over $2 billion. A quick evaluation of DCF model shows the current stock price is expensive. Assuming 15% growth in the next 5 years followed by 10% growth in year 6, and accounting for SBC, the intrinsic fair value of the company is $170.94/share.
My plan: Continue monitoring. If either the FCF growth rate ends up higher than expected or the stock price drops, this could be a great investment.
Stock #2 DaVita Inc (DVA)
Some services like ordering DoorDash or going to a movie theatre are optional. These services need to spend considerable effort to woo customers. But you know what’s not optional? Providing a life saving service that needs to be done regularly to keep you alive. Companies that provide these types of mandatory services also generate very consistent cash flow.
DaVita DVA 0.00%↑ is a leading provider of kidney care services. They specialize in providing dialysis treatments and operating both in the US and internationally. As of the end of 2024, DaVita operates around 3,166 outpatient dialysis centers, of which 2,657 were in the US and 509 centers were located in 13 countries outside of the US. These outpatient dialysis centers serve around 281,000 patients. In addition to this, they also provide other kidney related services which they call integrated kidney care (IKR) which includes things like management of diseases and home dialysis.
DaVita has a strong presence in this niche with them and Fresenius Medical Care being the two main dialysis providers in the US. Being part of the healthcare industry is also a positive as this industry grows faster than the overall economy due to the aging population living longer. Importantly, this company also provides an abundant free cash flow yield of over 9%. Berkshire Hathaway owns a substantial percentage of DaVita which should come as no surprise since this is exactly the type of company they look to invest in.
Valuing DaVita using DCF assuming 5% growth for the next 6 years and accounting for around $105 million SBC annually gives an intrinsic fair value of $125.66/share.
My plan: In addition to waiting on a slightly lower price, there’s one additional thing about DaVita that I am paying attention to. I have noticed their debt levels are considerable with over $12 billion in total debt as of the last quarter. Approximately 20%-25% of the operating income is going towards just servicing debt. Meanwhile, they continue to use this money to buy back shares aggressively. Leveraging like this could either be a very brilliant move or a very risky move. If rates come down though, they may stand to benefit considerably in their earnings.
Read about 3 more companies below!