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Investment Ideas Enghouse Systems: A premium-priced tech stock with a strong track record

Enghouse buys and manages software used for billing and logistics in sectors such as transportation, utilities and energy. It also handles customer service software, such interactive voice response systems, for financial services and health care customers.

NICKY LOH/REUTERS

Investors who turned their backs on resource stocks and took a chance instead on certain technology plays are being richly rewarded in today's market.

An example is Enghouse Systems Ltd., a Markham, Ont.-based consolidator of software companies, which has shot up about 35 per cent so far in 2015 and more than 70 per cent over the past year. The stock hit another record on Monday, surpassing $55.

Its valuation isn't cheap, but some argue investors need to pay a premium for companies such as Enghouse with a strong track record.

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"It's expensive … but you're paying for consistency of expectations," said Peter Hodson, chief executive at 5i Research, a Kitchener, Ont.-based investment research firm that targets retail investors.

He points to management's history of making shareholders money through a steady stream of global acquisitions. Enghouse buys and manages software used for billing and logistics in sectors such as transportation, utilities and energy. It also handles customer service software, such interactive voice response systems, for financial services and health care customers.

In 2014, Enghouse said it spent $45-million on five acquisitions, expanding its geographic reach into new markets across Europe and Latin America. The company's latest acquisition was in early March, when it paid $23-million for Denmark-based billing software company CDRator A/S, with customers across Europe, North America and Africa.

Mr. Hodson likes that Enghouse doesn't issue stock to make acquisitions, and that 28 per cent of its shares are owned by company insiders, including 17 per cent by chairman and chief executive Stephen Sadler.

Analysts appear to have the same faith in Enghouse, but are more divided on what they recommend investors do with the stock right now.

Two have a "buy" rating, while two say "hold," according to S&P Capital IQ. The consensus price target over the next year is $51.38, according to Thomson Reuters. The stock surpassed that level within days of reporting a 33-per-cent increase in first quarter revenue to $63-million, driven by acquisitions. Enghouse also raised its quarterly divided by 20 per cent, to 48 cents annually. It now yields about 1 per cent.

Enghouse shares have risen steadily since the 2009 recession, but picked up steam in late 2012, around the time investors began exiting the struggling resource sector and amid the company's own acquisition growth. The stock took off again late last year, after the company reached a $1-billion market cap, which increases its exposure to larger investors.

RBC Dominion Securities analyst Paul Treiber has an "outperform" (similar to "buy") rating on the stock and raised his target to $55 from $49 earlier this month, believing Enghouse is poised to pick up the pace of acquisitions to fuel future growth.

"In the last year, organic growth has steadily improved and acquisition momentum has accelerated," Mr. Treiber said in a recent note.

He also expects organic growth to "remain healthy," as the company boosts investments in sales and marketing around new product launches. However, that could squeeze margins in the short term, Mr. Treiber warns.

TD Securities analyst Doug Taylor is slightly more cautious on Enghouse, with a "hold" rating, saying the current valuation is fair, but he also increased his target price earlier this month to $52 from $45.

TD forecasts the company will spend about $50-million on acquisitions this year, and expects the stock to soon be included on the S&P/TSX composite index, which should also help to increase its profile.

Despite the strong growth signs, Andy Nasr, managing director and senior portfolio manager at Middlefield Capital Corp., remains leery of owning Enghouse at current multiples.

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Bloomberg statistics show the company's trailing price-to-earnings ratio is 55.3-times, while the S&P/TSX software industry index PE is 44-times, and the PE for the S&P/TSX composite index is 20-times.

"The stock seems very expensive," said Mr. Nasr, whose firm owns a few larger and cheaper U.S. technology names instead.

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