Versant's Persistency

Versant trades for just $33 million, despite no debt and a cash balance of $23 million. With this kind of profile, one would expect to find a company losing a whole lot of money. But this is not the case: Versant has remained profitable every year throughout this downturn!

Subtracting the company's cash balance from its market cap gives the company an enterprise value of just $10 million. This is essentially what the shareholder is paying for the company's operations. But over the last four years alone, Versant has earned a total of over $20 million!

The market's likely problem with this company is the trend of its earnings. Last year, Versant's earnings were less than $2 million, and this year they are on track to come in even lower than that.

The market always seems to punish companies with declining earnings, whether those declines are temporary or not. For long-term investors, therefore, the trick is to determine whether the company can get back to its previous level of earnings, whether its earnings are on a permanent slide, or whether it's too difficult to determine the company's earnings power.

The investor's ability to accurately ascertain the company's earnings power is dependent on his circle of competence. Versant operates in an industry where it is likely that only a fraction of potential investors are experts: Versant is a business-to-business provider of data management software.

There actually exists a real life example of just how hard predicting Versant's business can be. This otherwise reasonable article from 2008 (when Versant's earnings were much higher than they are today) discusses the persistence of this company's earnings. In the article, it is proposed that "Versant is deeply embedded into customer applications, making it difficult to switch" and that as a result, it is estimated that "two-thirds of revenue is of a recurring nature."

Two years later, Versant's revenue fell by more than a third while its profits plummeted far more than that. This example highlights just how difficult it is to make predictions; as such, investing on the basis of predictions is likely to lead to losses of capital, violating the first rule of value investing.

Though Versant's stock looks cheap, investors should beware. Only if the company falls within his circle of competence should the investor seek to buy this company's future earnings. There is no reason to expect (without a proper analysis that can only come from an understanding of this company's products) this company's future earnings to match those of its past.

Disclosure: No position

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please consider subscribing to the feed.