Overvaluation Concerns May Arise If AI Demand Falls Short

Key Takeaways

• Investments in generative AI and acquisitions could strain margins if revenue growth doesn't meet expectations, raising overvaluation concerns.
  
• Integration risks and tax rate increases may impact net income growth despite ambitious revenue targets and acquisitions.
  
• Strong financial performance, ongoing innovation, strategic acquisitions, and a robust cash position suggest sustained growth and improved investor confidence for Thomson Reuters.

Catalysts

Operates as a content and technology company in the Americas, Europe, the Middle East, Africa, and the Asia Pacific.

• The significant investment in generative AI offerings, which reached over $200 million in 2024 and is expected to continue at a similar pace in 2025 and beyond, could strain operating costs if the expected revenue growth does not match these investments, impacting net margins and earnings.
  
• The company foresees sustained double-digit growth in its Tax & Accounting segment, driven by acquisitions such as SafeSend and Materia. However, high fair value adjustments to acquired deferred revenue and expected integration costs could initially dilute margins and net income.
  
• Despite ambitious revenue growth targets for 2025 and 2026 (with an increase from previously guided ranges), if the demand for AI-enhanced products like Westlaw Precision and CoCounsel does not materialize as strongly as projected, it could undercut expected revenue, leading to potential overvaluation concerns regarding future earnings.
  
• While Thomson Reuters completed several acquisitions to bolster growth, there remains inherent risk if these acquisitions do not integrate smoothly or fail to generate the desired synergies and efficiencies, potentially impacting earnings growth negatively in the medium term.
  
• The expected increase in the effective tax rate from 18% in 2024 to approximately 19% in 2025 due to global minimum tax regulations could reduce net profit margins, potentially exerting pressure on net income growth projections and contributing to overvaluation concerns if not offset by sufficient revenue gains.

Thomson Reuters Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Thomson Reuters's revenue will grow by 6.4% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 30.2% today to 22.8% in 3 years time.
• Analysts expect earnings to reach $2.0 billion (and earnings per share of $4.53) by about April 2028, down from $2.2 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 48.3x on those 2028 earnings, up from 37.1x today. This future PE is greater than the current PE for the US Professional Services industry at 15.5x.
• Analysts expect the number of shares outstanding to decline by 0.1% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.05%, as per the Simply Wall St company report.

Thomson Reuters Future Earnings Per Share Growth

Risks

• Strong financial performance in 2024, with full-year organic revenue growth of 7%, and a projection for continued growth in 2025 and 2026, indicates a positive revenue outlook for Thomson Reuters, which contradicts the belief that share prices will decrease.
  
• Continuous investment in generative AI offerings and new product launches demonstrate Thomson Reuters' commitment to innovation, suggesting potential impacts on future revenue and net margins.
  
• Strategic acquisitions and M&A activity, such as the acquisitions of SafeSend and Materia, are expected to enhance capabilities and support sustained revenue growth, which may influence earnings positively.
  
• The company’s focus on maintaining strong customer relationships and a Build, Partner, Buy approach in AI indicates an ongoing investment strategy designed to improve long-term profitability and revenue.
  
• Thomson Reuters’ plan to raise dividends and its strong free cash flow and liquidity position demonstrate financial health, which could stabilize or increase share prices by supporting investor confidence and returning value to shareholders.

Valuation

• The analysts have a consensus price target of CA$250.073 for Thomson Reuters based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$279.56, and the most bearish reporting a price target of just CA$205.46.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $8.7 billion, earnings will come to $2.0 billion, and it would be trading on a PE ratio of 48.3x, assuming you use a discount rate of 6.0%.
• Given the current share price of CA$250.04, the analyst price target of CA$250.07 is 0.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.