The world’s best investors warn people against cutting the proverbial flowers to water the weeds, or selling their top performing investments while holding onto or even ploughing more money into their losers. I have heard it said time and time again that investors should “let their winners ride”, meaning that you shouldn’t sell a stock just because it has a good return on it. I have read many an article where seasoned investors chalk their biggest regrets up to “locking in gains” on investments that went on to compound still more. It is with these refrains echoing in my mind that I have elected to NOT sell my investment in Robert Half International (NYSE:RHI) in spite of a DCF analysis that indicates over-valuation at current levels and in spite of my having a 200% return on the stock in just two years.
My intent with this article is to outline why exactly I feel inclined to not touch my RHI position. Bottom line up front: RHI is a quality company that can still grow at a high rate. With no reason to question my original investment thesis, I am happy to collect a growing dividend, add to my position on any share price weakness, and avoid a taxable event that would be incurred upon selling.
Continued Excellence
In my first article on RHI way back in 2020 I highlighted several items that are worthy of an update.
First, of the three segments that RHI operates in, permanent staffing carries the highest margins followed by consulting/auditing and then temporary staffing, which is also their largest segment. Therefore, any growth in the other divisions will push up margins, and that has indeed been the case.
RHI has grown their consulting/auditing segment at an exceptional rate, far faster than the other segments, thus pulling overall margins up. In 2021 RHI had the highest operating margin in their history at 11.5%. The auditing segment makes up a larger percentage of their overall business every year, a trend that is set to continue and will have the continued effect of expanding margins:
Auditing/Consulting | 2019 | 2020 | 2021 |
% of Revenue | 18.58% | 24.69% | 28.67% |
% of Operating Income | 20.5% | 37% | 38% |
Part of my original thesis was that with the launch and growth of the auditing/consulting segment, which doesn’t follow the business cycle nearly as much as permanent/temporary staffing does, the company overall is becoming more recession resistant. This proved to be true in the throes of 2020 when the world was shut down to handle COVID-19. In spite of that environment, RHI saw continued growth in their auditing/consulting division of 12% over 2019. This helped RHI support earnings better than in the 2008 economic debacle, with a much less severe swoon:
Also worth mentioning is the continued robust showing in return on equity:
With such good business results, where in fact the business is stronger today than even it was two years ago when I first bought, why would I sell?
Those opposed to buy and hold strategies would remind me of one of the most commonly echoed investing platitudes: “buy low, sell high”. The problem with this is that it is only possible in retrospect to determine what low or high is. With a stock like RHI that tends to be more volatile, whose beta has never been at or below 1 since at least 2012, this is especially true.
While continued awesome business results and the difficulty of determining entrances and exits are the most compelling reasons for me to not sell my position, there are yet others.
Dividends
Let me be clear: I am dividend agnostic. I am a capital allocation zealot. I want money to be used for the right thing at the right time. If that means paying a dividend, great! But there are often (usually?) better uses for cash. I don’t buy stocks for their yield or their dividend growth story (don’t get me started on the completely fabricated dividend tiers of “challenger”, “champion”, or “aristocrat”…). Ultimately, when it really comes down to brass tacks, I absolutely concede that any business is only worth the present value of what it can eventually pay out in dividends. BUT, it is often the right thing to NOT pay a dividend today so that dividend payments can be BIGGER in the future. Investing back into the business proper at high rates of return, paying down debt, opportunistically buying back shares, and making wise acquisitions are all ways of giving up dividends today so that they can be exponentially larger later on.
All speeches aside, I will say that I am a fan of the RHI dividend. RHI generates so much cash that they can’t use all of it for the above mentioned purposes, so returning it to shareholders is the right thing to do. Because I have such a low cost basis, the forward yield on my shares is 4.5%. The dividend has grown at a tremendous rate, more than enough to beat inflation:
2017 | 2018 | 2019 | 2020 | 2021 | 2020e | |
Dividend | $0.96 | $1.12 | $1.24 | $1.36 |
$1.52 |
$1.72 |
– % growth | 9% | 16% | 10% | 9% | 11% | 13% |
Payout Ratio | 36% | 36% | 31% | 46% | 31% | — |
If they keep raising the dividend by at least 10% annually, I will have recouped my original investment in no more than 11 years. The most impressive part about this hypothetical situation is that the dividend 11 years down the road in 2033 still won’t have exceeded 2021’s earnings per share. A ten percent growth rate in the dividend through 2033 would amount to $4.90 a share at that time, and 2021 EPS was $5.36. They could grow the dividend at that rate and NOT need to grow earnings to do it! Not that I want that to happen…. The point I am trying to make is that RHI has a long story ahead of them of robust dividend growth as they continue to increase earnings and therefore the dividend at rates likely to exceed 10%.
Macro Environment and Valuation
The money that RHI makes is primarily a function and a reflection of overall employment and wages. RHI determines what they charge for their services based on number of employees and bill rates. With wages picking up steam and with the number of job openings in the United States at record highs, RHI stands to benefit significantly as they work to fill all those open positions. While their business results and their stock are at record highs, the larger economic landscape is still very conducive to further growth.
What kind of growth then is the market pricing RHI for? I put together a reverse engineered DCF analysis to figure it out:
A reverse engineered DCF analysis starts with the stock price. Then the inputs are fiddled to match. This allows us to put dollars and cents on market sentiment. Explanation of inputs:
– RHI grew revenue by 5.15% annually in the 2012-2021 period. The market is assuming that RHI can accelerate that pace and do 7.5% annually now through 2026.
– Cash from operations margin has averaged between 8% and 9% for the past ten years. This model assumes that they start at 10% and get it as high as 12% by 2026, representing significant expansion.
– CAPEX as a percent of sales has been an average of .75% of sales in the past few years. This number stays the same.
– Terminal value of 3%, meaning they grow FCF by 3% annually for the rest of forever after 2026.
– Discount rate set at 10%, the long-term average return of the stock market, and presumably the rate the market hopes to at least match.
In short, the market is expecting RHI to grow faster and have higher margins than they have historically been able to do. While I certainly think their future is bright, I am not convinced that revenue growth in the future will be able to eclipse the past since larger numbers get harder to compound at similar rates of return. That being said, I do believe they have plenty of room for margin expansion based on what was discussed earlier. I would also not be surprised if RHI totally surprises me to the upside. But my analysis indicates decent over-valuation. Popular valuation ratios also currently sit above RHI’s five-year average and above the relevant index:
Conclusion
To be honest, I did the research for this article in order to talk myself out of selling my RHI position. The temptation to sell was strong in order to lock in my 200% return. More than once have I had to deal with the regret of NOT having sold a position I had an awesome return on only to watch it sink later BELOW my cost basis. But I realize that those cases were different. Those positions weren’t in companies that were firing on all cylinders. Those companies didn’t have plenty of visible opportunity yet to take advantage of. With RHI, any share price weakness is an opportunity to add to the position. To put the cherry on top, selling my RHI position would create a taxable event. All these things taken together, I find it most prudent to sit on this excellent company for yet longer, valuation notwithstanding.