It’s been a full year since we initially highlighted Guidewire (GWRE) as a growth software company with utility-like revenue stability. No doubt inspired by the piece, GWRE has hummed from $25 to $41 – a gain of over 60%.
During that time, I have been selling covered calls on GWRE. My shares were called away several times, but I was fortunate enough to buy them right back afterwards. All-in-all I’d probably have been just as well off buying and holding GWRE as I was selling calls for income on my current shares – though I was more protected from downside employing the option strategy in tandem.
GWRE Valuation Update
As we’re patting ourselves on the back, we should take the time to reconsider Guidewire and ask if we didn’t yet hold a position here, would we start one? Let’s revisit – and update – our previous valuation thesis:
Guidewire sports a market capitalization of $1.35 billion, is sitting on a cash pile of $170 million, and no debt. So the company itself can be had for $1.18 billion.
While management does not provide growth projection guidance, it appears to be on track (based on a question answered during the last investor conference call) for at least the short term to achieve sales and earnings growth north of 30%.
Longer term, Guidewire believes there are 1000 additional insurance companies that need its software. And the current product set has not been fully sold into the existing customer base – in fact it thinks it can grow revenue four times just selling the existing product set to the existing customers.
For the sake of argument I’ll assume Guidewire can grow sales and earnings 25% per year for the next five years – and let’s toss in a sixth to make the math easy. This is a double across the board every three years.
Which means when we pull up this article in 2018 (on our iPad 8), we’ll wake up to a GWRE that sports four-quarter recurring revenue approaching $400 million, earnings-per-share around $2.80, and likely still has a lot of insurance companies to sell software to. Those numbers would probably make us happy with our buy-in price of $25 per share / $1.18 billion for the whole enterprise.
Guidewire now boasts a market cap of $2.34 billion, is sitting on about $100 million in cash, and still has no debt. So you’re paying $2.24 billion for the company today – almost double the $1.18 billion you could have picked it up for this time last year.
Our favorite four-quarter recurring revenue number increased 32% year-over year – from $96.3 million to $127 million. This was a pleasant surprise, as we had only pencilled in 25% growth.
Still, the stock is quite a bit pricier than it was a year ago with respect to our “keep a few core developers and just cash the checks” number (see the original article for a full description of this). Last year, we paid about 12x this number for shares of GWRE – this year, it’s 18.
Moving GWRE to a Hold
If you don’t yet own Guidewire, I’d stay on the sidelines and see if the stock gets unfairly punished after an earnings report. The long term story still looks great for GWRE, but you know how manic the market can be in the short term (and we’ve seen it before with GWRE, too).
If you currently own Guidewire – first, congratulations. Secondly, don’t forget to move your stops up to lock in your gains. A decisive break below $35 for GWRE would be a sell signal for me. Be sure to set a stop that flows with your trading strategy and goals.
Guidewire (GWRE) breaks out to all-time highs. (Source: StockCharts.com)
It’s very possible that GWRE could double again from here. It has a business model that parallels Wall Street Darling Salesforce.com – if GWRE garners a multiple that parallels CRM, there will be some room to run from here. That’s why I prefer to respect the trend from here, now that the valuation aberration has been closed to at least some extend.
Why Not Sell Covered Calls While We Wait
Finally, there are some nice premiums on the $45 call options for those of you inclined to sell covered calls while you sit and wait. The June 22 GWRE call options most recently traded hands for $1.05 – which would be a 2.5% return in just 46 days. Granted you’re giving up the upside above $45, but I’m willing to trade that in exchange for a 20%+ annualized return on shares that I’m going to keep holding anyway.
Past Analysis and Coverage on GWRE
Guidewire: A Growth Software Company with Utility-Like Revenue Stability (May 14, 2012)
Guidewire’s Ambiguous Earnings Results, and the Market’s Manic Reaction (June 10, 2012)
Selling Covered Calls on Guidewire (October 4, 2012)