Nova’s meteoric rise would be tough to spot without this unique screen
It is no secret that the world’s greatest investors understand the simple fact that as-reported financial metrics are unreliable
To consistently beat the market, they account for arbitrary accounting rules by adjusting the financial statements, which provides a true picture of economic reality and allows them to find companies that exhibit three characteristics: high quality, strong growth potential, and low valuations.
Today, we highlight our QGV 50, which emulates this investment strategy to produce outsized returns in excess of the market over long periods of time.
We’ll take a look at one company in particular on this month’s QGV 50, describing how as-reported metrics distort economic reality and can lead investors to miss significant opportunities.
Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.
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Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.
Legendary value investor Marty Whitman, whose Third Avenue Management funds consistently beat the market over the past 20 years, once stated that “a lot of what Wall Street does has nothing to do with the underlying value of a business.”
Investors who neglect the very real issues with as-reported accounting can find themselves caught up investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.
The most surefire way to mimic the success of greats like Whitman begins with developing a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.
The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies, but rather looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.
That’s exactly what we’ve set out to do with the QGV 50, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.
This list has outperformed the market by 300bps per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.
See for yourself below.
One of this month’s top QGV 50 names is Nova (NVMI), an Israeli company that produces the control systems semiconductor manufacturers rely on to operate their plants.
With chip manufacturers looking to spend billions of dollars to expand capacity and meet booming demand, one would imagine that a company helping the entire industry run more efficiently would be doing extremely well right now.
Yet, as-reported financial metrics show Nova, a company at the heart of the semiconductor manufacturing equipment industry, has return on assets (“ROA”) that has collapsed from 14% in 2017 to just 6% over the past three years.
In reality, Uniform Accounting metrics show that being an essential supplier to a booming industry leads to tremendous profitability, not returns barely above cost-of-capital levels.
Thanks to strong demand for its products as semiconductor manufacturers ramped up spending and investment, Uniform ROA actually exploded from 11% in 2016 to 91% in 2020. At the same time, the company has been actively re-investing in its future, with impressive asset growth of 17% last year.
With a Uniform P/E of just 8.8x, Nova also trades well below market averages, making it a compelling name checking off all the boxes of quality, growth, and value.
Looking at economic reality through the lens of Uniform Accounting, we can see why this innovative, high-growth company, which supplies a booming industry with strong secular demand tailwinds, was flagged by this month’s QGV 50.
If it were easy to find great companies with growth potential trading at favorable prices, professional investors would be out of the job. Yet, with Uniform Accounting it is, and that’s why the QGV 50 has had such tremendous success beating the market over the years.
To learn more about the QGV 50 and see the other 49 companies on the list, click here to get full access today.
SUMMARY and Nova Ltd. Tearsheet
As the Uniform Accounting tearsheet for Nova Ltd. (NVMI:USA) highlights, the Uniform P/E trades at 8.8x, which is below the global corporate average of 24.3x, but above its historical P/E of 5.0x.
Low P/Es require low EPS growth to sustain them. In the case of Nova, the company has recently shown a 29% Uniform EPS growth.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Nova’s Wall Street analyst-driven forecast is a 10% EPS shrinkage in 2021 and a 4% EPS growth in 2022.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Nova’s $104 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to shrink by 19% annually over the next three years. What Wall Street analysts expect for Nova’s earnings growth is above what the current stock market valuation requires through 2022.
Furthermore, the company’s earning power in 2020 is 15x above the long-run corporate average. Moreover, cash flows and cash on hand are 10x its total obligations—including debt maturities and capex maintenance. All in all, this signals a low credit risk.
Lastly, Nova’s Uniform earnings growth is below peer averages and the company is also trading below its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research