Small-Cap Tech Stock Outperforming Its Peers

With the markets remaining turbulent and the S&P-500 (SPY) suffering a five-day rout that’s sent it down 6.5% and down over 15% in the past 30 trading days, it’s understandable that some investors might not be in the appetite to buy.

Meanwhile, among those anxious to buy, they may be looking for stocks beaten up the hardest, with the potential to recover in sympathy with the general market.

The above strategy of buying the weakest stocks can work. Still, my preference is to buy those stocks that have given up ground grudgingly during the market’s decline, given that this often suggests they are being accumulated.

This strategy is especially effective if the stock has double-digit earnings/sales growth, which has become much harder to find during severe margin pressure for most companies.

Fortunately, one name currently fits the bill: a small-cap stock in the Computer/Software Enterprise group, Model N Inc (MODN).

A Leader In Revenue Management Solutions

Model N is a $1.2BB software company that was founded in 1999, with the “N” in Model N referring to “Next” or the next big thing.

The company offers Global Pricing Management and Global Tender Management solutions for the pharmaceutical industry. It also offers solutions for Channel Management, Deal Intelligence, and Payment/Price Intelligence for high-tech industries.

Since 2019, the company has grown its revenue at a compound annual growth rate of 17.4%, a very respectable rate for a company just starting to gain visibility due to its smaller size.

While many tech companies were busy posting top and bottom line misses in Q2 and Q3 is expected to be hairy, Model N put together a phenomenal Q3 report, beating revenue by $1.2MM and earnings by $0.09 ($0.23 vs. $0.14).

This was helped by strong net retention of 123% and a meaningful contribution from new SaaS deals (3 large deals closed), with many of Model N’s customers including Fortune 500 companies.

Notably, the company passed the elusive $100MM SaaS annual recurring revenue milestone in the quarter, with 24% growth year-over-year.

These robust results with revenue of $56.2MM (10% growth), and quarterly earnings per share of $0.23 (44% growth) combined with a new product release for its Revenue Cloud that offers enhanced automation and compliance for its Life Sciences Vertical have placed the company in a great position to end the year strong.

Model N’s management seems to share this view, guiding for revenue of $56.5MM in Q4, translating to 10% growth year-over-year despite lapping difficult comps, with 24% growth in the year-ago period.

So, with enterprise software being relatively recession-resistant and the company firing on all cylinders, there’s a lot to like about Model N.

The Fundamental Picture

From a valuation standpoint, Model N might appear expensive, trading at 59x FY2021 earnings. This valuation might suggest the stock is fully valued in a market where we’re seeing considerable multiple compression due to rising rates.

However, it makes little sense to value a growth stock on trailing earnings, and Model N is projected to grow annual EPS to $0.71 this year, with further growth to $0.78 in FY2023, translating to a 45% jump from FY2021 levels ($0.54).

Meanwhile, the company sports an incredible compound annual earnings growth rate of 81.1%, with annual EPS climbing from $0.04 in FY2018 to $0.78 in FY2023 based on current estimates.

On a PEG basis, and assuming a lower growth rate of 25%, Model N trades at a PEG ratio of 1.8, a very reasonable valuation for a growing tech company with a 16% return on equity, addressing a massive and growing market in life sciences and high tech.

So, while the PEG ratio is certainly high relative to stocks in other industries, it’s more than palatable given Model N’s strong operating performance.

The Technical Picture

From a technical standpoint, MODN has one of the best charts in the technology sector, outperforming 97% of its peers from a relative strength standpoint and trending higher above its 50-day and 200-day moving averages.

See the Full Technical Analysis Report for MODN

Meanwhile, the stock gapped up on 9x normal volume last month after the release of its Q3 earnings, suggesting that there appears to be a large appetite for the stock after its beat and raise quarter.

Finally, while the S&P-500 was down 4.6% last week, MODN put together a 2% gain, suggesting that there’s a good chance it’s under accumulation.

Given these positive characteristics, I expect the stock to perform quite well into Q4, especially if the market can put together a relief rally.

The Bottom Line

Based on MODN’s FY2023 earnings estimates of $0.78 and a fair earnings multiple of 52 (a 20% discount to a historical PE ratio of 65), I see a fair value for the stock of $40.60. This translates to a 27% upside from current levels.

From a technical standpoint, there is no real resistance for the stock until $37.50, pointing to a nearly 20% upside from current levels.

So, with MODN having momentum at its back and having one of the better earnings growth rates among its peer group, I expect the stock to be an outperformer and an earnings-beat candidate in Q4.

Disclosure: I have no position in any stocks mentioned but may initiate a position in MODN over the next 72 hours.

The above analysis of Model N Inc (MODN) was provided by financial writer Taylor Dart. Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

Is Model N Inc (MODN) A Buy or Sell?

Based on MarketClub’s technical analysis tools, Model N Inc (MODN) is in a strong uptrend that is likely to continue. With short-term, intermediate, and long-term bullish momentum, MODN continues to climb. Traders should protect gains and look for a change in score to suggest a slow down in momentum.

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