Perficient: Durable Growth Story, Overvalued

I've been a proponent of stay-at-home stock pickers focusing on small caps for a while, but there has been a lot of talk around the opportunities in small caps this year, based on valuation relative to larger caps. An example is what long time small cap fund manager Chuck Royce had to say on the topic:

"Both in terms of P/E and EV/EBIT (enterprise value over earnings before interest and taxes), many small caps look undervalued. They look even cheaper compared to large caps. Based on EV/EBIT, small caps remained close to 20-year lows relative to large caps at the end of September."

So this brings us to the company at hand, and it's not because there happens to be good value in small caps, but because the company is a good growth story in any environment.

Perficient, Inc. (NASDAQ:PRFT) is a consulting firm that specializes in digital transformation. They became public in 1999, below we see the share performance since then:

As you can see, the stock merely matched the market for many years, and only recently has it entered a new phase of performance. Starting near the peak of the tech bubble did play a huge role in that. So on the other end of the spectrum is their period of greatest returns:

Below we see how their revenue breaks down

They have achieved good growth through COVID-19 and show resistance to recessions so far.

Next is their return metrics versus peers:

They very recently appointed a new CEO from within, who has been with PRFT since 2008. Currently, there is 2.4% insider ownership, not very high for a company this size, but that doesn't make the company uninvestable for me.

Digital transformation as an industry is projected to grow at 24% CAGR until 2030. PRFT will certainly take part in this, but the growth of the past doesn't automatically guarantee that they are destined to be the next ACN, the giant of the industry.

Capital Allocation

PRFT is still a growth company, just a bit more mature than 20 years ago. They've never paid a dividend or meaningfully reduced share count. Acquisitions are a major part of their strategy, as we can see below how capital was allocated in USD millions:

Source

I do expect to see fewer acquisitions made with the use of debt due to higher rates now, which will probably mean less acquisitions overall.

Q2 Earnings

The company missed earnings in Q2, but I don't think this is the start of a new trend. With the general view being that a deep recession has probably been avoided, this is bullish for their short term earnings. Should we enter a serious recession, I don't expect them to lose money, but revenue growth will definitely slow. More on this in the risk section below.

Risk

One of the things I like the most about PRFT is their rising ROIC, but this brings along a risk of mean reversion, moving those returns in the opposite direction. Being a services business, they are inherently capital-light, and this bodes well for returns on capital. I don't see much general strategic risk, the bigger risk is in growth slowing and capital returns declining.

They have $60 million in cash versus $396 million in long term debt. Long term debt has been increasing over time, and while I'm not overly concerned right now, it wouldn't take much for it to get out of hand. The worst case scenario would be an acquisition that's less accretive than expected, purchased at too high of a price, and with debt used to fund it.

Valuation

Share prices reached an all-time high of $153.28 back in November 2021, and have declined almost 60% since then. First, we'll look at the historical multiples:

There isn't any discount in terms of the multiple, and historically we still aren't at a very low level, it's merely a cooling off from being in bubble territory in 2021. Next is the DCF model:

My earnings estimates are bullish but still conservative. I like the prospects for returns on capital to stay at this level for the next few years and maybe increase, but I just can't get there on the price today. I will give this stock a "hold" rating, but it is definitely worth seeing if the company can improve qualitatively while it grows.

Conclusion

PRFT has been a great small-cap growth story, and it produced incredible returns only if bought and sold at the right times. The growth is safe, but this has never been a stock you can tag along to at any price. Valuation will always matter with this stock, sheer EPS growth won't be enough to generate any alpha, you must pay the right price and now isn't the time.