The past month has been challenging for the market. Although some stocks are beginning to show signs of recovery, most remain below their February highs. This is what makes the performance of one particular stock notably compelling. It is impressive in its own regard, but even more remarkable for resisting marketwide challenges to continue reaching multiyear highs, reflecting strong investor confidence in the underlying company’s future.
The stock in focus is VeriSign (VRSN), and while it is recommended to take note, potential investors might want to hold off before taking any action.
What is VeriSign?
VeriSign may not be a familiar name in every household, yet it is likely that many individuals indirectly benefit from its services daily. VeriSign operates as a web-domain registry, registering websites ending with ".com" or ".net." It also manages domains ending in ".cc" and ".name," and offers related services such as domain-name cybersecurity. Without VeriSign’s services, the internet would face significant challenges, with multiple entities potentially attempting to use the same domain name.
There is a fee involved in registering website names, which is what makes this business lucrative. As the sole entity authorized by ICANN to manage the naming of ".com" and ".net" websites, VeriSign effectively operates a legal monopoly.
Despite its strengths, VeriSign is not considered a growth business. Its top-line growth for the previous year was 4.3%, aligning with long-standing norms, and this year’s projected revenue growth is similar. The stock’s 35% increase from its November low is intriguing, particularly since such movement is typically seen in stocks with higher growth projections.
Upon closer examination, the stock’s steady rally aligns with certain rationales, largely credited to Warren Buffett’s Berkshire Hathaway. Already a significant long-term investor, Berkshire Hathaway increased its stake in VeriSign near the end of last year, sparking a sustained wave of bullish activity.
The Argument for Caution
While Warren Buffett’s investment strategies are highly regarded, and Berkshire Hathaway consistently outperforms the overall market with time, his decision to buy doesn’t necessarily translate into an immediate purchase recommendation for others.
Following a 35% gain since late November, VeriSign’s valuation has escalated to 28 times the expected earnings per share of $8.68 for this year. Buffett acquired shares at approximately 23 times the projected profit, which was not cheap but was reasonable at that time.
Investors can sometimes be overly cautious about stock valuations, potentially missing out on solid long-term performers. However, sensible limits exist. Even Buffett emphasizes the importance of purchasing shares at prices significantly discounted from underlying business values. With revenue growth regularly under 5%, VeriSign’s nearly 30 earnings multiple challenges the boundaries of what Buffett typically considers a fair price.
Buffett’s infallibility is not guaranteed. For instance, in 2019, he acknowledged that Berkshire "overpaid" for Kraft in 2015 when it merged with Heinz.
Moreover, differing expert opinions exist. Managers of the Weitz Multi-Cap Equity Fund, Wally Weitz and Drew Weitz, expressed concerns over Verisign’s lack of volume growth potential, prompting their exit from the position in favor of other opportunities.
Weitz’s caution is understandable. With over 200 million current dot-com websites and countless others using the .net and .name domain suffixes, the market’s demand for new websites is dwindling. Long-term forecasts predict business growth of only about 5% over the coming years, driven largely by reregistration maintenance revenue. As the market becomes more saturated, the necessity for new websites diminishes further.
The connection becomes clear: not a high-growth industry, eventually, the business may only sustain itself. Additionally, despite high profit margins, VeriSign is not offering dividends in the interim.
Limited Upside Potential
These observations do not suggest that Buffett and Berkshire Hathaway were incorrect in increasing their stake in VeriSign. Berkshire’s historical success speaks for itself.
However, individual investor circumstances may differ from Buffett’s position. While Buffett can afford to endure potential underperformance, others may not have the same luxury to wait for indefinite progress. Given that VeriSign constitutes only about 1% of Berkshire’s portfolio value, an increase in shares late last year does not significantly impact Berkshire.
For investors seeking Buffett-endorsed investments with substantial commitment, Apple, Chevron, and Coca-Cola remain major holdings of Berkshire Hathaway and possibly present more promising opportunities than VeriSign, especially following its recent rally. The stock’s sharp upturn might not be sustainable.
A potential strategy is to await a significant downturn as a more opportune entry point.
