Warren Buffett is known for buying shares in businesses that have huge competitive advantages. And they don’t come much more difficult to disrupt than VeriSign (NASDAQ:VRSN).
High barriers to entry, low capital requirements, and solid growth prospects make a formidable investment proposition. But the stock’s down 15% over the last five years and close to a 52-week low.
What is VeriSign
One of the first things businesses do is establish an internet presence by building a website – typically ending in ‘.com’. When they do this, they register their domain name to prevent anyone else using it. VeriSign is the company they register their addresses with. The firm operates the registry of websites ending in ‘.com’, ‘.net’, and ‘.edu’.
Importantly, it has a contract with Internet Corporation for Assigned Names and Numbers (ICANN) giving it the exclusive rights to do this. So anyone wanting a .com website has to pay VeriSign.
The .com contract only runs for six years – and it expires in November – so there’s technically a risk. But there’s also a right of renewal if VeriSign maintains a reliable service, which it has done so far.
Financials
VeriSign is an outstanding business and it shows in the firm’s financials. Providing an indispensable service in an important industry has generated 4% annual revenue growth since 2014.
Operating margins have expanded from 56% to 67% over the last decade. By anyone’s standards, that’s huge and the company’s ability to maintain these demonstrates how difficult it is to disrupt.
In addition, VeriSign’s low capital requirements have allowed it to return significant amounts of cash to shareholders. Through share buybacks, the firm has reduced its share count by 26% over 10 years.
The result has been 12% annual growth in earnings per share and a 257% increase in the company’s share price. But with the business still looking resilient, why has the stock been going down lately?
Valuation
The short answer is valuation – as Buffett points out, it’s always possible to pay too much for a business, no matter how wonderful it is. And VeriSign has been a good demonstration of this recently.
Five years ago, the stock traded at $207 and the company made around $6 a share in free cash flow, implying a 3% annual return. The business hasn’t changed much since then, but the investing landscape has.
Specifically, interest rates have increased. A 3% return might have been attractive when a 10-year government bond was yielding 2%, but it isn’t with bond yields at 4.5%.
That’s why the VeriSign share price has been falling and there’s a risk it might continue to do so. If interest rates don’t fall as quickly as investors expect, the stock could well go lower from here.
A buying opportunity?
Rather than predicting what interest rates and bond yields might do in the future, I’m focusing on the current opportunity. And with the stock down 20% over the last year, I think there’s an opportunity.
VeriSign generated $7.81 in free cash per share last year, which is a 4.3% return at today’s prices. Given the likely growth ahead of the business, considering locking that in today could be a smart move.
The post This underappreciated Warren Buffett monopoly could be a smart buy after a 20% drop appeared first on The Motley Fool UK.
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Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
