My Winners and Losers in the First Half of 2018

Tom Macpherson

My Winners and Losers in the First Half of 2018

Each year my colleague John Dorfman writes an article discussing stocks that are in most of Dorfman Value Investment’s (DVI) client portfolios and that he also owns personally. In our team approach, John has Katharine Davidge and myself pick a percentage of stocks for the model portfolio used as the basis for many clients’ accounts. In addition, I manage some accounts mostly on my own with a few picks from John. At DVI, we think the blending of styles of each team member makes for a greater whole.

In my previous life as a managing partner at a consulting firm, I used to update readers with a report on the two best performing stocks in my company’s internal stock portfolio as well as the two laggards. In today’s article, I am returning to that format.  Here are my two best and worst stocks in 2018 through mid-June.

The Winners

Veeva (VEEV): Up  49.9% YTD

Veeva Systems was the first provider of customer relationship manager (CRM) designed specifically for biopharma. Nearly every biopharma company will tell you Veeva’s products and services are both mission critical and impossible to replace with another provider. It has 650 customers around the world.  Client satisfaction measured by retention rate for this software is roughly 90-95%. With roughly 65% market share, Veeva should be able to grow as the biopharma industry does. This year has seen the rollout of Veeva Vault, a cloud-based application.

Veeva believes it has touched on roughly only 40% of client functionality and technology requirements. It recently launched Veeva Nitro, a data warehouse built specifically for biopharma commercial business. Nitro is designed to be the platform for future growth in business intelligence (BI) and artificial intelligence (AI).

I believe there remains a strong high single digit growth opportunity in biopharma over the next two decades. On top of this, Veeva is making a concerted effort to move into adjacent industries.  In addition to biopharma, it is marketing to large academic researchers, health care facilities, and industrial manufacturers. With these new markets coming into play, I project low double digit free cash flow growth over the next 15-20 years.

The company grew revenue by 19.3% year-over-year (YoY) from 2017 to 2018. Free cash flow and earnings grew by 36.6% and 54.2% over the same time frame. Return on capital (ROC) is coming in at 67.2% versus a weighted average cost of capital (WACC) of 9.5%. Gross margins, free cash flow margins and net margins are 69.2%, 32.4% and 20.8% respectively. The company has no short or long-term debt and $918M in cash on the balance sheet.

I bought our position in Veeva in February, 2018. With the jump in price, I took some profits in Q2 of 2018. That said, I plan on continuing to take advantage of Veeva’s deep moat, high returns, and management’s excellent capital to drive returns for the long term.

F5 Networks (FFIV): Up  38.3%

F5 Networks is a leader in the application delivery controller (ADC) market.  An ADC is a  device in a datacenter that helps perform common tasks. This includes such tasks as removing load from the web servers. Many also provide load balancing. FFIV’s products are recognized by most Fortune 500 companies as well as service providers for the ability to manage and secure network traffic coming in and out of corporate IT departments.

F5 remains the clear industry leader in the ADC market with 50% market share. It also leads in profitability.  The industry average of FFIV’s competitors’ net profit margins was 14.1% in 2017. F5’s was 28.1%. This type of market domination and corresponding profitability makes F5 a compelling investment — if it can be purchased at a reasonable valuation (see below for my thoughts on FFIV’s value today). In 2016 and 2017, FFIV launched more product than they have over the preceding past 8 years. The switch towards emphasizing service contract revenue (i.e. recurring revenue) in addition to providing equipment (which was the company’s primary focus historically) bodes well for margins and cash flow.

The company grew revenue by 12.8% year-over-year (YoY) from 2017 to 2018. Free cash flow and earnings grew by 14.2% and 14.3% over the same time frame. These numbers represent roughly one-half of growth achieved over the past ten years and I expect growth to ramp up to more historical levels over the next 2-3 years. The company has return on capital (ROC) of 85.4% versus a weighted average cost of capital (WACC) of 8.1%. Gross margins, net margins, and free cash flow margins are 83.1%, 20.4%, and 34.1% respectively. The company has no short or long-term debt and $1.03B in cash on the balance sheet representing 40% of all assets.

When I first purchased FFIV in July 2017, I was confident the market was underestimating the company’s growth over the next 5 – 10 years. While my confidence is still strong in the company, the dramatic increase in price over the past six months has brought valuation to nose bleed levels. I took profits earlier in 2018 and am contemplating taking more as of June 2018.

The…..Not So Much Winners

For me, nothing is more disturbing than reading a self-congratulatory article about the writer’s genius for buying right at the low and selling just at the peak. One isn’t sure which is worse: the writer has convinced himself this reflects skill rather than luck, or the writer feels compelled to share this delusion with his or her readers. For me, great articles are those where the writer addresses a mistake head on and identifies the decision-making and response to a real bone-headed investment decision. It’s much easier to learn from a mistake than to try to replicate success that may result from dumb luck.

That said, my two laggards this year haven’t been disasters for which I will be remembered into the future. Be assured there are several of those. This year’s laggards have been profitable investments since purchase, but seen reverses in the first half of 2018. In both cases, I strongly believe in each company’s competitive moats and long-term growth potential.

Novo Nordisk (NVO): Down  -15.5% YTD

As a pioneer in diabetes care, Novo Nordisk has been developing diabetes care products since early 20th century. It currently controls slightly over one-quarter of the $45 billion branded diabetes treatment market. The next two decades will see enormous growth in the diabetes market. Baby boomers and obesity will increasingly be an issue with diagnosis and treatment of the disease projected to increase until 2037. As a leader in modern insulin analogs, NVO leads in long-term (Levemir) and short-term (Novolog) as well as oral-to-injection transition (Victoza). The company just had a significant boost in clinical trial data showing its ultra-long insulin is more effective, offers superior flexibility in dosing, and poses less risk of hypoglycemia than competing products. I expect Novo Nordisk to increase both revenue and market share by high single digits (or even low double digits) over the next two decades.

Continued talk about price controls and pricing pressure (two very distinct issues) have plagued NVO’s stock since the beginning of the year. Mixed messages from the Trump administration on price negotiations have played a significant role in creating a drag on NVO’s stock price. I believe most of this talk is overblown. Regardless of one’s position on biopharmaceutical drug pricing, the ability to pass legislation to bring about change is highly unlikely.

Additionally, while the bulk of NVO’s profits come from the United States, a worldwide trend of increased healthcare spending and diabetes treatments in Asia, Africa, and South America will drive revenue over the next several decades. Combined with the Baby Boomer generation hitting 65, I think time and the diabetes markets will provide strong tailwinds to NVO through 2040.

The company saw revenue decrease by 0.30% year-over-year (YoY) from 2017 to 2018. Free cash flow decreased by 32.7% while earnings increased by 2.7% over the same time frame. These numbers represent significant drops compared to growth achieved over the past ten years. New product launches and commercial strategies (including cost cutting) should help ramp up these numbers to more historical levels over the next 2-3 years. The company has return on capital (ROC) of 65.8% versus a weighted average cost of capital (WACC) of 9.0%. Gross margins, net margins, and free cash flow margins are 84.0%, 35.2%, and 26.3% respectively. The company has no long-term debt and $3.01B in cash on the balance sheet representing 17% of all assets.

We bought our shares in September 2016 and have seen a 15.5% return since purchase. The stock currently trades at a 3% discount to my estimated intrinsic value.

Manhattan Associates (MANH): Down  -4.1% YTD

Manhattan Associates develops, sells, deploys, services and maintains software designed to manage supply chains, inventory and related information for retailers, wholesalers, manufacturers, logistics providers and other organizations.

MANH is a wonderful company that usually flies below the radar of mid-cap money managers but is too large for small-cap managers. Including my time at Nintai Partners, I have been an investor with Manhattan Associates since 2003. I greatly admire both their business model and management’s capital allocation skills. Since I purchased the stock in Q4 2016 I have (obviously) been disappointed in the stock price. However, I still believe the business model is solid and that management hasn’t lost a step in its business acumen. I first bought shares of MANH in July 2016.  My confidence is high enough that I’ve made five additional stock purchases over the past 18 months as the stock price decreased from $52 to $41. I am currently down 6.5% since my initial investment.

I have tendency to discount earnings in my valuation process and focus mostly on free cash flow (though my partner John Dorfman has me thinking hard about this!). Much of the stürm und drang with the stock has been based on changes in earnings and nothing to do with free cash flow. As an example, in October 2017, the company announced its 2018 earnings would be negatively affected by FASB ASC Topic 606 guidelines. At the same time, free cash flow is estimated to be up by 11% over the same period. Much like the referee at the end of Caddyshack, I am keeping an eagle eye on the metric that most matters to my valuation – free cash. Additional spending on its new Active platform has been supported by new deals such as MANH’s deal with Esselunga, an Italian supermarket chain. I would be remiss to not point out that management has decreased its share count from 130.4M in 2003 to 67.7M in Q12018. I think this has been extraordinarily astute use of capital.

The company saw revenue increase by 0.80% year-over-year (YoY) from 2017 to 2018. Free cash flow decreased by -1.7% and -8.6% over the same time frame. The transition from software to software as a service (SaaS) cloud-based services has taken longer than MANH’s estimates so we expect growth to pick up over the next few years. The company has return on capital (ROC) of 81.8% versus a weighted average cost of capital (WACC) of 8.9%. Gross margins, net margins, and free cash flow margins are 58.4%, 19.1%, and 23.6% respectively. The company has no long-term debt and $126M in cash on the balance sheet.

Total Returns

For the 12 months through March, returns of Dorfman Value accounts I personally manage have been 20.71%, versus 13.98% for the S&P500. Please be aware that past performance does not predict future results. Performance will vary with economic and market conditions. Comparison with the Standard & Poor’s 500 is for reference, but some of my accounts invest in smaller stocks and stocks outside the U.S. The S&P 500 is a large-cap U.S. index.  If you want more information on my returns and those of our firm, please visit

Thomas Macpherson is a portfolio manager at Dorfman Value Investments LLC in Newton Upper Falls, Massachusetts.  He can be reached at  

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