The Appen Ltd (ASX: APX) share price skyrocketed from just under $8 to $12 in a 52-week time frame from the start of 2018. A 50% share price gain for the year would be an outstanding result for most individuals. In the last few months, Appen's share price has further accelerated up to an all-time high of close to $26 earlier this month.
Many investors and professionals can agree that Appen has been a star performer in the last couple of years. However, they may have different opinions on Appen's current valuation.
Why do I think Appen is still a buy?
By taking a big picture view of Appen's business model, you notice it integrates perfectly into the fourth industrial revolution: data and machine learning. Appen's primary business is to improve machine learning on a large scale with the use of data. Appen will work with other businesses to provide the training data that they require for their machine learning and artificial intelligence.
Based on the 2018 annual report, Appen currently trades on a 12-month trailing PE of 56.43. On first appearances, Appen's share price appears shockingly expensive but this valuation can be deceiving. From the 2018 annual report, it is evident that Appen has increased total revenue by 119%, underlying EBITDA by 153% and underlying NPAT by 148%, in a 52-week timeframe. It doesn't stop there. The increase in Appen's cash flow is organic. This means that Appen is relying on growth from its own business operations rather than obtaining cash from external sources.
As a growth company, Appen is not focused on paying dividends to shareholders and is instead rewarding them with capital growth. This can be reflected in its payout ratio of 10.2 which indicates only 10.2% of its total earnings are paid to shareholders as dividends. The leftover cash goes back into Appen itself.
We can see that Appen uses this spare cash to acquire companies with strong synergy as shown recently by Figure Eight. When this acquisition was publicly announced, Appen's share price fell 7%. However, the next morning, Appen's share price jumped 6% and continued to trade higher. It's very rare to see the share price of an acquiring company recovering one day after its initial acquisition announcement. Given the outlook for Appen, this was no surprise.
Foolish takeaway
Don't be deceived by the standard price to earnings valuation, instead think big picture and focus on future growth. Appen could well be a star performer for many years to come.
For other growth stocks, be sure to check out these top 3 dividend bets for 2019.
