The EVA Monster Series: The Unseen Hand Guiding the Digital Revolution

With this series, we’d like to give you some perspective on the companies in our distinguished EVA Monster universe. This rare breed of quality-growth stocks is worthy of your attention, and getting to know these businesses may pay off handsomely down the road.

As a quick recap, EVA Monsters have three things in common:

  • They earn high returns on the capital they employ.
  • They have growth opportunities that allow them to reinvest most of their cash flows at high rates of return.
  • They have a sustainable competitive advantage (that Warren Buffett calls “moat”), which prevents their competitors from taking away their extraordinary profitability.

These characteristics tend to result in a strong (double-digit) fundamental return potential, meaning that no valuation tailwind is necessary to get great investment results with EVA Monsters. (These case studies explain this pretty well.)

As Charlie Munger said:

“Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns 6 percent on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6 percent return – even if you originally buy it at a huge discount. Conversely, if a business earns 18 percent on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with one hell of a result.”

We also shared the math proof of why buying EVA Monster stocks at a fairish valuation makes perfect sense for long-term investors. (Look for the “math example” in this post to alleviate your doubts.)

To round off the short introduction, we (1) try to avoid overpaying for EVA Monsters, (2) closely monitor the fundamental performance and management’s capital allocation decisions throughout our holding period, and (3) hold our positions as long as the underlying investment thesis remains intact, ideally for decades, to let compounding do the heavy lifting.

Without further ado, numbers prove that Accenture (ACN) is a true EVA Monster, and building a position in the company would be a great way to get indirect exposure to the overall digitalization megatrend.

Accenture is a leading global professional services company that assists businesses and other organizations in constructing their digital core, optimizing their operations, and accelerating revenue growth. Its activities include strategic management consulting, technology services (e.g. implementing cloud transformation), and managing back-end systems such as finance and accounting, procurement, or human resources. Additionally, the firm offers adjacent services in engineering and advertising strategy. The company was founded in 1951 and is based in Dublin, Ireland.

The company began as the business and technology consulting division of the accounting firm Arthur Andersen in the early 1950s. It was headed by the renowned engineer and inventor Josepf Glickauf, one of the first advocates of using computers in business and the “father” of the computer consulting industry. In 1989, Arthur Andersen and Andersen Consulting became separate units. After a long and bitter dispute, the latter gained independence and changed its name to Accenture in 2001.

As complex as Accenture’s business model may appear, its essence is rather simple: it monetizes the working hours of its staff with a markup. This added value is facilitated by the continually nurtured expertise, predominantly in highly skilled fields, emphasizing the implementation of new technologies for its clients.

Revenue generated from the cloud transformation of its customers constitutes the largest portion of Accenture’s top line (~42% as of fiscal 2022), encompassing activities such as data migration, modernizing enterprise resource systems, and enhancing AI capabilities. Closely associated is cybersecurity (~10%), spanning from threat intelligence to managed security services. From a different perspective, Accenture’s revenue streams involve 13 distinct industry groups (such as consumer goods, software & platforms, and insurance), each generating over $1 billion in revenue, with none responsible for more than 15% of companywide sales. The firm’s revenue is roughly evenly divided between consulting arrangements, typically lasting less than 12 months, and managed services contracts, usually spanning several years.

At first sight, Accenture’s competitive advantage appears hard to grasp, as, unlike technology companies, it does not have blockbuster products to offer, such as Microsoft Office or Adobe Photoshop. Its competitive edge can be best understood by considering its know-how flywheel.

The firm uses its vast resources to build expertise mainly in emerging digital technologies, spreads the cost over several hundred thousand employees, and offers consulting services for mission-critical applications at a premium to its own labor cost. Specifically, the firm’s treasure trove of experience in serving various industries enables it to offer tailored solutions for highly specialized application areas.

We believe that the two-step business model provides a unique way to extend client relationships and, ultimately, the lifetime revenue realized from a specific project. In a nutshell, after using Accenture’s consulting services to integrate a new system, customers can opt to have it managed by the company in subsequent years. This creates undeniable switching costs, as it is unlikely that a client will transition the outsourced management of an existing system to a competitor unfamiliar with it and risk day-to-day operations.

All this results in exceptional customer loyalty, as 98 of Accenture’s top 100 clients have been with the company for over a decade, turning to its consultants repeatedly through business cycles and technology shifts.

It is evident that the capital-light nature of the underlying business, coupled with significant pricing power, results in exceptional quantitative metrics. Accenture stands firmly above the market’s average, boasting ROC levels in the 30-40% range and an EVA Margin of around 10%. The diversified and largely recurring revenue streams support the thesis that the firm deserves a wide-moat classification.

Source: ISS EVA, The FALCON Method

As for the future, the IT and business services sector is likely to continue its GDP+ expansion trajectory, as the digitalization of businesses through cutting-edge technologies is a nearly endless source of growth. Accenture’s management estimates that within its client base, 40% of workloads are in the cloud, only one-third have modernized their enterprise resource planning (ERP) platforms, and less than 10% have mature data and AI capabilities.

Turning to capital allocation, Accenture typically reinvests around 40-50% of its internally generated cash at exceptional ROC figures. Part of it goes to building new competencies and know-how in-house, but acquisitions remain the primary use of reinvested cash. We really like the firm’s acquisition strategy of extending competencies through smaller, bolt-on acquisitions in high-growth areas and then leveraging the knowledge base to bolster organic growth. This strikes us as a low-risk, high-reward way of enhancing Accenture’s competitive position and growth profile.

Accenture’s cash-generative, capital-light model means that, besides reinvesting, there is plenty of cash left to distribute to shareholders. The company has maintained a 19-year dividend-raising streak, with healthy growth rates and a safe payout ratio. Although the current entry yield of 1.7% is far from glamorous, it is still above the market average. The firm is also a regular repurchaser of its shares, but we have reservations about the opportunistic nature of this activity, as Accenture has not abandoned buybacks even when the stock seemed significantly overpriced.

Looking at the stock’s valuation, Accenture’s stock has been highly rated since 2016, as the market appreciates its operational stability, diversified customer base, and attractive growth runway, all with a low probability of disruption to its business model. Please see below the valuation metrics of the EVA framework that remedy accounting distortions to give us a clearer picture on where the stock stands in a historical context.

(Curious why we don’t use the most popular multiples? Find out here!)

When comparing today’s valuation to historical averages, there appears to be a healthy dose of optimism surrounding the stock, even though the market-relative valuation seems fair. With the baked-in EVA growth of nearly 13% over the next decade, we believe now is not the time to get excited. The 5-year total return potential chart speaks for itself.

Source: ISS EVA, The FALCON Method

The FALCON Method can identify much better opportunities in the current market, so we are passing up on Accenture for now.

The verdict

One of the most prominent challenges Accenture faces is keeping up with the pace of innovation in the technology sector. To remain the consultant of choice, the firm must either build internally or acquire the skills needed to stay at the forefront of its industry. While management understands this source of competitive advantage very well, the fact that Accenture “jumps” on every new trend means there will surely be some dead ends along the way, with areas that don’t develop as management hopes (let’s see where the metaverse goes, for instance). This should be considered a cost of doing business.

The composition of Accenture’s employee base also carries a certain level of uncertainty, with more than half of its workforce residing in India or the Philippines, where the base salary is relatively low (~$7,000 per year) and attrition is notably higher than at most U.S. firms. Moreover, since the company basically follows a cost-plus-margin business model, upward pressure on compensation will translate to higher prices for its customers, which could hinder growth.

While challenges like new competition from cloud service providers or potential harm to the company’s reputation do pose threats, we would be more than willing to buy shares at the right valuation. Despite their risks, the growing importance of cloud-based solutions and the AI revolution could bode well for the company’s consulting services as the technology landscape becomes increasingly complex. We think the firm’s proven, resilient business model, enviable ROC metric, and double-digit fundamental return potential translate to a bright future. As for position sizing, we would be comfortable with a 3-5% exposure.

The company ranked 26th of our 60 EVA Monsters at the time of writing, based on its 5-year total return potential. (Businesses from 12 countries are represented on our EVA Monster list.)

It is safe to say that there are far more attractive EVA Monster stocks to buy in the current market, with the highest-ranking ten boasting total return potentials above 14% over our modeled 5-year timeframe. (You can always find the monthly Top 10 in the FALCON Method Newsletter along with our entry price recommendations.)

Want to learn more about our ranking methodology? Start with this blog post!

You can also learn more about our stock-picking process and follow David’s evolution in the Beyond Dividends book.
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