Every month, we feature a stock from our Most Attractive Stocks Model Portfolio and another stock from our Most Dangerous Stocks Model Portfolio. Both featured stocks this month have been in their respective Model Portfolios for multiple consecutive months.
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We update these Model Portfolios monthly and September’s Most Attractive and Most Dangerous Stocks Model Portfolios were updated and published for clients on September 5, 2024.
August Performance Recap
In the Most Attractive Stocks Model Portfolio, the best performing large cap stock gained 20% and the best performing small cap stock was up 13%. Overall, 20 out of the 40 Most Attractive stocks outperformed the S&P 500.
In the Most Dangerous Stocks Model Portfolio, the best performing large cap short stock fell by 6% and the best performing small cap short stock fell by 12%. Overall, 20 out of the 40 Most Dangerous stocks outperformed the S&P 500 as shorts.
This report leverages our cutting-edge Robo-Analyst technology to deliver proven-superior[1] fundamental research and support more cost-effective fulfillment of the fiduciary duty of care.
All of our Most Attractive stocks have high (and rising) return on invested capital (ROIC) and low price to economic book value ratio. Most Dangerous stocks have misleading earnings and long growth appreciation periods implied by their market valuations.
Most Attractive Stocks Feature for September: Industrials Company
This company has grown revenue and net operating profit after tax (NOPAT) by 5% and 11% compounded annually since 2013, respectively. The company’s NOPAT margin increased from 13% in 2013 to 24% in the TTM and invested capital turns rose from 0.4 to 0.8 over the same time. Rising NOPAT margins and invested capital turns drive return on invested capital (ROIC) from 6% in 2013 to 18% in the TTM.
Figure 1: Revenue and NOPAT Since 2013
Sources: New Constructs, LLC and company filings
This Most Attractive Stock Is Undervalued
At its current price of $87/share, this stock has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means the market expects the company’s NOPAT to permanently decline by 10%. This expectation seems overly pessimistic for a company that has grown NOPAT by 11% compounded annually since 2013 and 3% compounded annually since 2018.
Even if the company’s NOPAT margin falls to 21% (below TTM NOPAT margin of 24% and five-year average of 23%) and revenue grows just 3% (below ten-year compound annual growth rate of 5%) compounded annually through 2033, the stock would be worth $107/share.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
Below are specifics on the adjustments we made based on Robo-Analyst findings in this featured stock’s 10-Qs and 10-Ks:
Income Statement: we over $150 million in adjustments, with a net effect of removing over $60 million in non-operating expense. Professional members can see all adjustments made income statements on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: we made around $1.8 billion in adjustments to calculate invested capital with a net decrease of over $360 million. One of the most notable adjustments was over a billion in deferred tax assets. Professional members can see all adjustments made to balance sheets on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: we made over $3.4 billion in adjustments to shareholder value with a net decrease of over $2.2 billion. Apart from total debt, the most notable adjustment was for excess cash. Professional members can see all adjustments to valuations on the GAAP Reconciliation tab on the Ratings page on our website.
Most Dangerous Stocks Feature: Industrials Company
This company’s NOPAT margin fell from 12% in 2018 to 10% in the TTM while invested capital turns fell from 0.8 to 0.6 over the same time. Falling NOPAT margins and invested capital turns drive down the company’s ROIC from 10% in 2018 to 6% in the TTM.
The company’s economic earnings, the true cash flows of the business, which take into account changes to the balance sheet, have fallen from $178 million in 2018 to -$434 million in the TTM. Meanwhile GAAP net income has risen from $549 million to $765 million over the same time. Whenever GAAP earnings rise while economic earnings decline, investors should take note.
Figure 2: Economic vs GAAP Earnings Since 2018
Sources: New Constructs, LLC and company filings
This Stock Provides Poor Risk/Reward
Despite its poor and declining fundamentals, this stock is priced for significant profit growth, and we believe the stock is overvalued.
To justify its current price of $131/share, the company must improve its NOPAT margin to 15% (equal to best-ever NOPAT margin) and grow revenue by 14% (compared to 8% over the last decade) compounded annually through 2033. In this scenario, the company grows NOPAT 19% compounded annually to $4.1 billion in 2033. We think these expectations are overly optimistic, especially considering the company’s NOPAT has grown only 5% compounded annually over the past five years.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
Below are specifics on the adjustments we made based on Robo-Analyst findings in this featured stock’s 10-Qs and 10-Ks:
Income Statement: we made $435 million in adjustments, with a net effect of removing over $130 million in non-operating expense. Professional members can see all adjustments made to income statements on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: we made over $6.3 billion in adjustments to calculate invested capital with a net decrease of over $4.0 billion. One of the most notable adjustments was over one billion in deferred tax assets. Professional members can see all adjustments made to balance sheets on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: we made over $3.3 billion in adjustments to shareholder value with a net increase of over $2.5 billion. The most notable adjustment to shareholder value was for total debt. Professional members can see all adjustments to valuations on the GAAP Reconciliation tab on the Ratings page on our website.
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