Softcat (LSE: SCT) is a stock I’ve been bullish on for a long time. I see the FTSE 250 tech stock as a great way to play the ‘digital transformation’ theme. Indeed, I already have a decent-sized position in SCT within my own investment portfolio.
This week, Softcat’s share price has surged. Currently, the stock is up about 13% for the week. Meanwhile, over a 12-month timeframe, it’s up about 70%.
Is it time to take some profits after this share price run? Or should I hold on to the stock for further gains? Let’s take a look at the investment case.
Softcat: strong H1 results
The reason Softcat’s share price has jumped this week is half-year results for the period ended 31 January, posted on Tuesday, were strong.
While revenue was only up 10.1%, gross profit and operating profit were up 20.4% and 41% respectively. Meanwhile, earnings per share for the period were up 39.5%. The company lifted its interim dividend by a huge 18.5%, which suggests management is confident about the future.
The outlook was particularly encouraging. The company said it has good momentum early in the second half of the financial year and that the period has begun well. It also said it’s confident full-year results will be “significantly ahead of its previous expectations.”
Overall, H1 results were very impressive, especially when you consider the challenging economic environment in the UK.
Has Softcat’s share price run too far?
After the recent share price, Softcat shares do look quite expensive. Currently, analysts expect the company to generate earnings per share of 43.4p for the financial year ending 31 July 2021. This means that at the current share price, the stock has a forward-looking price-to-earnings (P/E) ratio of 40.7. That’s a high valuation and doesn’t leave much of a safety margin.
Having said that, Softcat is a high-quality company so it deserves a premium valuation, in my view.
This is a company that’s generated very consistent revenue and profit growth since its Initial Public Offering (IPO) in 2015. Over the last five years, revenue has jumped 81%. And it appears to have plenty of room to grow due to the fact that businesses really have to digitalise today if they want to remain competitive.
“We are optimistic about the growth opportunity in our market,” Softcat said earlier this week.
Softcat is also extremely profitable. Over the last three years, return on capital employed – a key measure of profitability – has averaged 68%. That’s an outstanding level of profitability.
Finally, Softcat has a solid balance sheet with minimal long-term debt.
SCT shares: my move now
Weighing everything up, I’m going to hold on to my Softcat shares for now.
There are risks to the investment case, of course. The high valuation certainly adds some risk. After a 50% share price rise in the last four months, a pullback is a real possibility. Another risk to consider is that UK businesses could cut back on tech spending after Covid-19.
However, right now, the trend here is up. So, I’m going to let this winner run.
Edward Sheldon owns shares in Softcat. The Motley Fool UK has recommended Softcat. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.