EPAM - May 2015 Portfolio Review #6

As you know, at year-end, I reviewed each of my stocks, and talked about what happened with the stock since I bought it. Now that we are in May, I decided to bring up to date as many of them as I have the energy for. This is EPAM, the sixth of these updates.

I just started a small 2.3% position in EPAM about four months ago, at $46.75. It has been as high as $69.50 and is now at about $65.50. It’s now up to 5.3% of my portfolio, by a combination of price increase, and by my adding to it as I became more confident in the company. (I’ve added all the way up, and have never sold any). My initial investment is up 40% in four months.

I had never heard about this company but learned about it from Anirban’s posts… I then found out it had been recommended by a paid service about a year and a half ago. Here are some excerpts which are somewhat paraphrased as they come from my own notes, to give you an idea what it’s all about. Remember these excerpts are well over a year old. By the way, it’s a NYSE traded company.

EPAM is a provider of outsourced software services for software vendors, financial institutions, media conglomerates, and consumer companies. Arkadiy Dobkin, who owns nearly 7% of the company, is creating a tech-services powerhouse by leveraging the skills of thousands of programmers from his native Belarus and other Eastern European countries.

A computer programmer by training, Dobkin relocated to New Jersey in the early 1990s and started writing programs with a classmate back in Minsk. Before long, he founded EPAM out of his bedroom and was developing commerce platforms for large multinational clients such as Adidas and Colgate-Palmolive. Today, EPAM employs more than 9,300 highly educated IT professionals, many living in Belarus and other Eastern European countries. Its clients range from Google and Oracle to Expedia and Coca-Cola.

EPAM’s focus is on sophisticated software development services, using what is known as the “Agile” methodology to collaborate on product development across teams, on the fly, and in real time. The Agile process is popular and well received by many consumer-facing companies. This isn’t low-grade offshore tech outsourcing, but rather fully engaged software development. EPAM’s delivery centers are located to attract smart, experienced, yet underemployed, engineers living across Eastern Europe. And they enjoy the work: According to company review site Glassdoor.com, EPAM scores a solid 4 stars out of 5, and Dobkin has an impressive 97% approval rating.

EPAM gives its clients massive levels of flexibility and cost savings in creating, testing, and implementing all kinds of software solutions. Six years ago, more than half of the company’s revenues came from a few tech companies, but today that is down to just a quarter. Financial and banking clients now make up 28% (up from 13% in 2008), and travel and consumer companies are more than 20% (up from 11% in 2008). Half the sales come from clients in North America and a third from Europe. No single client is more than 10% of annual revenues. About 94% of clients work with EPAM for more than a year and 78% for two years or more. And the number of clients who generated more than $1 million in revenues rose to 95 during 2013, a 17% jump.

The asset-light business model means high profit margins, healthy returns on capital, and a balance sheet packed with cash and receivables (70% of the company’s total assets). Annual growth rates have consistently exceeded 25%. Cash goes into capital expenditures and the occasional acquisition. I do think EPAM will beat its peers and the market over the next several years. For the year, Dobkin expects earnings growth of 18% to 20%, entirely doable considering the market opportunity and track record. If EPAM matches the high end, we’ll see cash earnings of about $2 this year, meaning shares fetch about 21 times earnings. If Dobkin and his team can continue to deliver as tech needs grow ever more complex, I think we’ll see growth rates exceed 15% for the next several years and a stock closer to $60.

The current situation with Russia does demonstrate the risk of major operations in a foreign country. While the largest grouping of EPAM engineers work in the Belarus Hi-Tech Park, some do live in the Ukraine, mostly in Kiev… Yet considering what we know about EPAM’s founder, the company’s software development edge, and the market opportunity, EPAM becomes quite intriguing. It may be a 20-year-old company, but it’s new to the public markets and few analysts follow it. Demand for flexible, complex software development continues to grow, and EPAM is run by a young guy with substantial equity tied in, and who garners overwhelmingly positive reviews on Glassdoor.

Please note the real risk, with this crazy war going on in the east of the Ukraine!!! Now here’s what their revenue looks like, in millions of dollars:

2012 – xxx xxx xxx 126 = 434
2013 – 124 133 140 158 = 555
2014 – 160 175 193 202 = 730
2015 – 200

Revenues for 2014 were up 31.5% from 2013, which in turn were up 28% from 2012. Not bad for revenue. They estimate 213-215 for the next quarter, which I assume means they expect about 218 to 220.

Now, let’s look at their earnings.

2012 – XX XX XX 37 = 142
2013 – 35 40 43 48 = 166
2014 – 47 53 60 62 = 222
2015 – 61

Here’s what their trailing earnings look like for the past seven quarters:

155
166
178
191
208
222
236

Calculating the rate of growth of earnings we take 236 divided by 178 and discover that they are growing at 32.6%. Their PE is 27.8 at yesterday’s closing price of $65.60, so their 1YPEG is a respectable 0.84. Anything below 1.00 is good, but lower is better. It’s not a world beater like SWKS, but a good steady grower.

Earnings growth may be accelerating as earnings grew 17% from 2012 to 2013, but 34% from 2013 to 2014, despite the distractions of the war in the Ukraine. (Its headquarters are in Pennsylvania, by the way).

Obviously this is an interesting and well-run company, with a history of good growth of both revenue and earnings, but there is considerable political risk with all this rebellion floating around. As far as the strong dollar, that actually will be a benefit, reducing their costs when figured in dollars. In my initial write-up I suggested you keep your position small because of military risk in the region, but I see that I didn’t entirely follow my own advice, as I now am up to a 5% position and it’s small to middle size for me.

Saul

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I just started a small 2.3% position in EPAM about four months ago, at $46.75. It has been as high as $69.50 and is now at about $65.50. It’s now up to 5.3% of my portfolio, by a combination of price increase, and by my adding to it as I became more confident in the company. (I’ve added all the way up, and have never sold any). My initial investment is up 40% in four months.

I’ve noticed in several posts that you seem to buy your positions a bit at a time. I’m curious if this is just the draw of the cards or if you have some method to accumulate positions.

EPAM Systems intrigues me because I was in the same business. We were just two of us, not 14,000 like EPAM, 165,000 like Infosys (INFY), or 211,500 like Cognizant Technology (CTSH). Ryan designed the websites and I wrote the back end. Ryan was a fantastic designer located in New Zealand, I’m located in Venezuela, we both used a web host in Los Angeles owned by an Aussie and had joint clients in Britain, Australia and New Zealand. I also had customers in Norway, the US, and Venezuela. We met on the Internet in an investing forum, he followed me to our web host, and one day he asked me to solve a coding problem he had. That led to a multiyear collaboration until cancer got him. It is quite amazing how easy it is to set up a multinational operation with the help of the WWW.

EPAM has at least two huge competitors (if not outright competitors, in the same kind of business), India based Infosys, and New Jersey based Cognizant (careful – the X-axis of the charts is not the same scale):

EPAM: http://softwaretimes.com/pics/epam-05-09-2015.gif
CTSH: http://softwaretimes.com/pics/ctsh-05-09-2015.gif
INFY: http://softwaretimes.com/pics/infy-05-09-2015.gif

What I find interesting is, first, the volatility which makes them great trading stocks, and second, how their grow rates taper off as they grow.


 **--------- Growth ---------**
**Symbol  15-yrs  10-yrs   5-yrs**
EPAM                     54.1%
CTSH     28.0%   16.9%   13.0%
INFY     10.9%    6.3%    0.9%

Finally, if EPAM follows CTSH’s footsteps, it’s going to be a great investment! (Infosys is nothing to write home about).

http://softwaretimes.com/pics/epam-ctsh-05-09-2015.gif

Denny Schlesinger

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I’ve noticed in several posts that you seem to buy your positions a bit at a time. I’m curious if this is just the draw of the cards or if you have some method to accumulate positions.

hi Denny, I almost always start with a small position while I’m getting acquainted with the stock. Then as time goes by, and earning reports accumulate, I tend to either add to or exit the position. Thus my biggest positions are ones I’ve held for quite a while usually. I don’t just buy a big position off the bat, although I’ll occasionally take a mid size position quickly if I fall in love with it.

Hope that helps

Saul

This, of course, is part of the art of your success, Saul … holding small positions of things that do poorly (and getting rid of them early) and holding substantial positions of things that do well (and continuing to hold them until they are doing less well).

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hi Denny, I almost always start with a small position while I’m getting acquainted with the stock. Then as time goes by, and earning reports accumulate, I tend to either add to or exit the position. Thus my biggest positions are ones I’ve held for quite a while usually. I don’t just buy a big position off the bat, although I’ll occasionally take a mid size position quickly if I fall in love with it.

Hope that helps

Saul

Most helpful! Until now I’ve classified stocks on a siding scale of mainstream vs. speculative and taken position sizes accordingly, full for mainstream and starter positions for speculative. I would then trade the starter positions to accumulate shares while reducing the cost basis. This has worked remarkably well even with stocks that went nowhere but it fails miserably with stocks that only go down because I won’t sell short ever. With fast growers it’s best to just hold or buy more.

Maybe I should use starter positions on all stocks.

Denny Schlesinger