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In this stock screen, we set out to find equities that have underperformed thus far in 2013, yet still command relatively high valuations and have shown solid revenue and cash flow growth of late. In order to identify stocks that once had sky-high valuations but have since come back down to earth to a degree, we screened The Value Line Investment Survey for equities that have delivered a negative total return thus far in 2013, a stark contrast to the 19% gain recorded by the Dow Jones Industrial Index over that same time frame. Next, we made sure that sales and cash flow had increased by more than 30% in the past year and the price-to-earnings multiple was above 20. Finally, we required the stocks have a market cap above $1 billion in order to capture larger, more established companies. The resulting list of five stocks can be seen below. Of these, we have chosen to highlight VeriFone Systems (PAY).

VeriFone Systems

VeriFone designs, markets, and services merchant-operated and self-service point-of-sale (POS) electronic payment terminals for the financial, retail, petroleum, government, transportation, and health care vertical markets. VeriFone’s brand name, large footprint, and contributions to technological innovation have made it one of the largest providers of electronic payment systems worldwide. The company had the following geographic revenue breakdown in the July quarter: The Americas, 44% (28% for the U.S. alone); Europe, Middle East and Africa, 43%; Asia, 13%.

Since VeriFone bought rival Hypercom in August 2011 (sans its U.S. operations), the payment terminal market has been dominated by only one other player, French-based Ingenico. In the U.S., VeriFone provides payment terminals for approximately 75% of the top 200 retailers.

In general, most of VeriFone’s customers will replace their existing terminals every five years or so. This noncyclical turnover, combined with its geographically diverse footprint, and lucrative software, maintenance, and taxi advertising revenues makes for consistently high sales and free cash flows.

Nonetheless, VeriFone dropped the ball in a big way in late 2012. The company underestimated the amount of R&D expenditure and employees needed to satisfy the changing security and transaction requirements of certain foreign governments. This caused PAY to lose share of the European market to Ingenico. Further, VeriFone’s sales team was allowing customers to defer payments on hardware in order to lock in lucrative long-term service contracts and, in turn, get higher compensation for themselves.

As a result of these missteps, revenues dropped significantly, as did the shares, falling over 40% in one day. This contributed to former CEO Doug Bergeron stepping down. The company has yet to fill its vacant CEO spot, but a search committee is currently looking for a full-time replacement.

Although the company admitted to its mistake and set out to right the ship, the severity of the matter was understated, and PAY missed its guidance for the April quarter and aggressively cut its business outlook for 2013, sending the stock price 26% lower.

The company has shown progress in its turnaround efforts as July-quarter sales were not as bad as expected. Revenues of $418 million exceeded the company’s guidance of $400 million. Too, non-GAAP earnings per share of $0.24 were higher than the expected $0.20. As a result, investors have flocked back to the stock, erasing the loss experienced in early June. Still, the stock has not recouped all of the steep loss felt in February 2013, and is still down 21% on the year.

The company is working hard to gain local certifications around the world. PAY has also ratcheted up R&D, authorizing increases in the number of engineers and sales people. VeriFone has long been adept in developing quality, innovative technology, and we think it will be able to regain its old position in the payment industry. In addition, global transactions continue to move toward credit card payments and away from hard currency, a trend that should let VeriFone grow its earnings over the long term. We think the worst is likely over for the company and suggest investors take a closer look at this company.

  

Company Name

Ticker Symbol

Sales Growth 1-Year

Total Return YTD

Current P/E Ratio

lululemon athletica LULU 36.08 -14.35 33.98
Verifone Systems PAY 41.68 -24.33 21.17
Auxilium Pharmac. AUXL 45.96 -1.46 264.71
Fusion-io Inc. FIO 58.35 -36.81 94.67
Mellanox Technologies MLNX 80.21 -36.24 27.08
InterDigital Inc. IDCC 140.85 -9.85 168.95

 

 

At the time of this article's writing, the author did not have positions in any of the companies mentioned.