Is Open Text Corp. Too Expensive Now?

I was surprised to see Open Text Corp. (TSX:OTEX)(NASDAQ:OTEX) stock pop up as much as 15% on Thursday. By the market close, the optimism toned down, and the stock was roughly 12.7% higher compared to where it was on Wednesday.

Is the stock overvalued now? Before looking at its valuation, let’s take a look at why the shares were elevated.

What caused the share price jump?

Open Text reported excellent results on Wednesday with total revenue growth of 35%, and operating cash flow growth of 56% year over year. Moreover, the tech company’s annual recurring revenue saw growth of 31% year over year.

Looking at the first half of the fiscal year, total revenue growth was 33%, and operating cash flow growth was nearly 30% year over year. Comparing the same period, the tech company’s annual recurring revenue grew 30% year over year. The annual recurring revenue makes up about 70% of its total revenue, which should lead to largely consistent profits.

How Open Text grows

Open Text primarily grows via mergers and acquisitions. A part of the strong double-digit growth that we saw came from its successful integration of Dell’s Enterprise Content Division, which Open Text acquired in early 2017.

At the time of the acquisition, Open Text believed that the acquisition will strengthen its market-leading position in the Enterprise Information Management software and cloud services space.

Open Text is a consistent performer

Open Text has delivered returns on equity and returns on assets of north of 11% and 5%, respectively, every year since 2010. Last year’s returns were especially phenomenal with return on equity and a return on assets of 37% and 16%, respectively.

Is the stock too expensive now?

The stock traded in a sideways channel for about a year before it shot up on Thursday. The market was in wait-and-see mode with regards to the Dell division integration. Since it went well and the company came out with double-digit growth, the stock reacted by rising higher.

More good news was that management estimates the company’s adjusted operating margin in 2021 will be 36-40%, which is higher than the 2020 target of 34-38%. (The recent adjusted operating margin was 36.5%.) Higher margins mean more profitability.

At the recent quotation of $47.50 per share, Open Text trades at a forward multiple of 19.1. This is inexpensive for a company that’s expected to grow its earnings per share by about 18% per year for the next few years.

However, the company will continue to make strategic acquisitions, and there’s always the risk of overpaying for companies and integration issues. That’s why Open Text’s eight-year normal multiple is roughly at 14 — which is lower than its growth rate.

Investor takeaway

Open Text is a well-managed, global technology company with lots of runway to grow. The company sees the room for global expansion and the opportunity to expand its Enterprise Information Management portfolio to include artificial intelligence, Internet of Things, and information security.

Since the stock has just run up, it is unlikely to move much higher in the near term. That said, the dividend-growth company is reasonably valued today. Interested investors can begin scaling in to the stock. Cautious investors should buy on any weakness — perhaps a dip to the low $40s.

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Fool contributor Kay Ng owns shares of Open Text. The Motley Fool owns shares of Open Text. Open Text is a recommendation of Stock Advisor Canada.

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