I’ve been tempted to buy this FTSE 100 for years but one thing stopped me. It was too expensive. Too popular. Just too darn good.
The company in question is Sage Group (LSE: SGE), which develops accounting and payroll software for businesses worldwide. All the share price seemed to do was climb higher and it looked expensive with a price-to-earnings (P/E) ratio of around 34. I thought it was one to buy on a dip, and now we have one.
Sage Group has slumped
When I checked the list of best and worst performing FTSE 100 stocks in August, I was shocked to see Sage at the bottom. The shares fell 13.7% in the month, cutting annual growth to 6.7%. They’re still up almost 50% over five years, with dividends on top, so long-term investors won’t be too worried. What explains this sudden slump?
On 30 July, it reported that Q3 total revenue rose 9% to £1.86bn, which seemed fine, while management kept full-year guidance unchanged. This wasn’t a company in crisis. In fact, it looks in fine fettle, with recurring revenues and subscription income both marching upwards, giving the board much greater earnings visibility.
So, why the negative market reaction? Perhaps investors expected more. With sky-high valuations like this one, even a decent set of results can fall short of expectations. The shares fell in the immediate aftermath, with no subsequent news to lift them up.
High price to earnings
The stock has long been priced for perfection, and when that happens, the smallest wobble can spark a correction. Even after August’s slump, the P/E sits at 28.7. That’s still far above the wider market average, although Sage has long commanded a premium.
I’ve gradually eased my strict preference for lowly-rated companies. All too often, they’re cheap for a reason. Paying more for quality can work out well, provided the fundamentals hold up. However, expectations remain high, so Sage has to deliver otherwise investor disappointment could grow.
Sage also carries specific risks. Artificial intelligence could allow customers to replicate services in-house, denting its edge. Competition from rivals in cloud-based software is another.
Dividends keep flowing
At first glance, the 1.88% traidling yield doesn’t look much. Yet Sage has lifted its dividend every year since 1988. Over the last 15 years, payouts have compounded at just over 7% a year, comfortably ahead of inflation.
The reason the yield looks low is simply because the share price has run so strongly in recent years. Income investors shouldn’t dismiss it on that basis, as it still combines reliable dividends with steady long-term growth.
Broker forecasts underline the potential. The consensus one-year target is 1,375p, which is 27% above today’s 1,089p. Which would be a stunning return if it happened. As ever, it’s not guaranteed, and I suspect many of those forecasts will have been made before the recent slump.
My view
To me, this looks like the market taking a more realistic view after years of relentless optimism. For long-term investors building a Stocks and Shares ISA, Sage is worth considering on today’s weakness. It remains a quality blue-chip with dependable income, strong recurring revenues, and a proven model. Having waited so long for a dip, I’m now considered seriously considering taking advantage of it.
