It’s probably the best performing small cap business over the past 5 years on the ASX, with the Pro Medicus Limited (ASX: PME) share price rising from 80 cents in April 2014 to $15 today and its CEO seems to think the shares are still cheap.
According to conventional thinking if a company launches a share buyback it’s generally because it feels the stock is undervalued relative to its outlook, as otherwise it would be a poor use of company capital to buy overvalued or roughly fairly valued shares.
Especially if you’re a fast-growing software business such as Pro Medicus in a race for global market share that in theory could cost a lot in marketing and sales expenses to win new clients, but still produce a strong return on investment.
As such share buybacks are generally considered as good options for companies flush with cash (after asset sales or a commodity price boom like BHP Billiton Limited (ASX: BHP), or for mature companies with little use for piles of excess cash.
However, Pro Medicus is unusual as a junior software business in that it both pays a dividend and launches share buybacks which would be a sacrilegious act for for growth-focused software rivals like Xero Limited (ASX: XRO) or WiseTech Global Ltd (ASX: WTC).
Today, Pro Medicus gave a regulatory filing indicating that it might buy back up to 10% of its shares on issue over the next 12 months, which seems unlikely given it has a market cap of $1.5 billion. Therefore 10% of shares on issue would be $150 million and way beyond Pro Medicus’s free cash flow firepower to complete.
Even if it only buys back a couple of million dollars worth of shares this would be a mistake if the shares are overvalued, as it could lift the dividend as an alternative if it felt it didn’t need the cash.
Recently we saw management at junior software rival Adacel Technologies Ltd (ASX: ADA) complete a share buyback program before the share price bombed on the back of some poor operating updates that management should have forseen better than anyone.
No wonder investor confidence is shaken in Adacel.
Given Pro Medicus is reportedly led by a smart CEO it seems bullish that the company is even contemplating buying back shares as the free cash flow could be saved for a rainy day, dividends lifted, or marketing investment cranked higher.
However, perhaps the company is so confident of good times ahead it’s clever to buy the shares back now before they rise later on more good news. After all the stock is up 18x in 5 years and it’s not for me to criticise a management team that has delivered such stupendous performance.
I still only have a very small position in Pro Medicus unfortunately, but it does look to tick the boxes as a growth investment prospect. However, whether the shares offer any value at $15 is up for debate and I’ll sit on the fence with a hold.
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Tom Richardson owns shares of Pro Medicus Ltd. and Xero.
You can find Tom on Twitter @tommyr345
The Motley Fool Australia's parent company Motley Fool Holdings Inc. recommends Pro Medicus Ltd. The Motley Fool Australia owns shares of and has recommended Pro Medicus Ltd. The Motley Fool Australia owns shares of WiseTech Global and Xero. 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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