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Why I’m kicking myself for missing out on Appen Ltd shares

One stock on the market I regularly kick myself about not owning is machine-learning high flyer Appen Ltd (ASX: APX), despite having this business recommended to me a good three years ago by a highly-respected investor.

Back then the stock sold for 70 cents versus $11.25 today, which means I’ve missed out on some eye-watering gains.

Still I can’t help wondering whether the stock is likely to deliver good returns over the next 5 years if I bought it today.

After all thinking you’ve ‘missed the boat’ on a growing business is an amateur investing mistake that can exclude you from the best growth businesses on the share market.

Take the rise of online property advertising platform REA Group Limited (ASX: REA) for example.

In 2006 REA Group shares changed hands for $2.60 and recently climbed to above $90 on a valuation near $12 billion, with the group boasting a reasonable outlook for more share price growth ahead.

Needless to say if you can buy and hold huge winners like this you can build serious wealth over time.

So let’s take a look at Appen and its potential.

Currently it’s valued around $1.175 billion and delivered an underlying net profit of $19.7 million on revenue of $166.6 million for its financial year ending December 31 2017. The profit and revenue growing 86% and 50% respectively on the prior year.

The group also delivered underlying EBITDA (operating income) of $28.1 million in 2017 and recently forecast 2018 EBITDA to come in close to $55 million thanks to the contribution from new acquisition Leapforce, and some strong organic growth.

Assessing valuations of fast-growing companies using trailing metrics is not particularly useful, but using a back of the envelope calculation we can see that the business is selling for around 21x forecast EBITDA.

Again though, EBITDA is not a great valuation metric for a growth business as operating cash flow excludes potentially significant capital expenditure, tax, and interest costs before we can get to the real deal of free cash flow left over for investors.

Despite this it’s clear Appen is on a big valuation given a large part of its ability to nearly double EBITDA in 2018 is down to its $105.3 million Leapforce acquisition.

The valuation is partly justified by Appen’s position in the growing fields of data analytics and artificial intelligence, which suggests it should deliver some strong growth for the decade ahead.

Moreover, its content data business is growing strongly with revenue up 72% to $126.2 million in 2017. Its data-driven language services business is also delivering strong top line growth, with Appen counting tech giants such as Apple, Facebook and Google among its clients.

This suggests it has high-class products and something of a moat or competitive advantage which should help it protect or grow profit margins. This is a key quality of any business able to deliver long-term growth to investors.

The balance sheet has cash in hand of $24 million and net debt of $43.9 million after the Leapforce deal. The net debt is less than 1x the forecast for 2018’s EBITDA to be close to $55 million and as such the balance sheet is in reasonable if not pristine condition.

Unfortunately my day job means I don’t have time to dive deeper into the Appen investment case for now, although it is on my watch list for further research and I’ll let readers know if I do take a nibble at the stock.

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Motley Fool contributor Tom Richardson owns shares of REA Group Limited, Apple, Facebook and Google.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia owns shares of Appen Ltd. The Motley Fool Australia has recommended REA Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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