Don’t be fooled by the histrionics and high-flying stunts. World Wrestling Entertainment is an excellent business. With a return on invested capital over 22%, it is one of the most profitable companies in the United States. Excess cash is $207mm, more than 20% of the company's market value.
Ford gets our Dangerous Rating. This means F has poor quality-of-earnings and an expensive valuation. For example, F's ROIC at 0.6% is in our Bottom Quintile. And the valuation of the current stock price ($15.07) implies the company will grow its profits at 10% compounded annually for over 40 years. The takeaway: avoid this stock.
Over the past 10 years, ARBA appears as quite a success story and one of the few ‘internet bubble’ companies to survive and reach profitability, on a GAAP accounting basis at least. Looking beyond the reported accounting results, however, reveals that ARBA is not quite as profitable a company as it seems, and its valuation has out-grown its profits by a wide margin – the required combination of factors for making February’s list of most dangerous stocks.
Misleading earnings: NYX reported a $957mm increase in GAAP earnings while our model shows economic earnings declined by $641mm (a difference of $1,599mm or 34% of 2009 revenues during the last fiscal year. The majority of this disconnect comes from asset-write offs of $1,249mm, which equals 12% of reported net assets.
Of the 561 technology stocks we cover, IDTI is one of the 77 that get our “very dangerous” rating and one of the few that make our most dangerous stocks list for January. The tech sector is tricky because there are several large-cap excellent stocks (MSFT, ADI and AAPL) that make the sector look very good and offer good hiding for some “very dangerous” smaller-cap stocks such as IDTI.
Red flags:
1. Misleading earnings: BJRI reported a $3mm increase in GAAP earnings while our model shows economic earnings declined by $2mm (a difference of $5mm or nearly 40% of reported net income) during the last fiscal year.
2. Very dangerous valuation: stock price of $34 implies BJRI must grow its NOPAT at over 20% compounded annually for 15 years. A 15-year growth appreciation period with a 20%+ compounding growth rate sets expectations for future cash flow performance quite high. Historical growth rates are much lower.
3. Free cash flow was -$83mm or -11% of the company’s enterprise value last year.
4. Off-balance sheet debt of $265mm: 79% of net assets and 25% of market value.
5. Outstanding stock option liability of $44mm or 5% of current market value.
We went on record that investors should short SBUX on 11/6/2006 when the stock was close to $38 per share. Click here to see the Fortune Article. The stock did not look attractive to us until 2 years (11/18 – 11/20/08) later when it was under $8, and that for only about 3 days. And ever since we have had a Neutral or Dangerous Rating on the stock.
RED FLAGS:
1. Misleading earnings: DFS reported a $295mm increase in GAAP earnings while our model shows economic earnings declined by $998mm (a difference of $1,293mm or over 100% of reported net income). The majority of the overstated reported earnings comes from a one-time gain from an anti-trust settlement of $1,892mm.
2. Very dangerous valuation: stock price of $19 implies DFS must grow its NOPAT at over 10% compounded annually for 40 years. A 40-year growth appreciation period with a 10%+ compounding growth rate sets expectations for future cash flow performance quite high. Historical growth rates have never been much lower.
3. Free Cash Flow was -$2,470mm or -26% of the company’s enterprise value last year.
4. Asset write-offs of $428mm or 5% of net assets – this means that management has written off at least $0.05 of assets for every $1 on the current balance sheet. Writing off assets is the opposite of creating shareholder value as it reflects management’s inability to derive any profits for the investments it makes with shareholder funds.
5. Off-balance sheet debt of $38mm or 0.5% of net assets.
6. Outstanding stock option liability of $8mm or less than 1% of current market value.
The December version of our Most Attractive Stocks and Most Dangerous Stocks reports are now available for purchase. Note that Barron's recently recognized our Most Attractive Stocks portfolio as #1 over the prior 12 months amongst the best of the Wall Street research firms.
Red Flags:
1. Misleading earnings: JDAS reported a $14.6mm increase in GAAP earnings while our model shows economic earnings declined by $12.9mm (a difference of $27.5mm or 155% of reported net income).
2. Very dangerous valuation: stock price of $27 implies JDAS must grow its NOPAT at over 20% compounded annually for 10 years. A 10-year growth appreciation period with a 20%+ compounding growth rate sets expectations for future cash flow performance quite high.
3. Free Cash Flow was -$203mm or -15% of the company’s enterprise value last year.
4. Asset write-offs of $21mm or 3% of net assets – this means that management has written off at least $0.03 of assets for every $1 on the current balance sheet. Writing off assets is the opposite of creating shareholder value as it reflects management’s inability to derive any profits for the investments it makes with shareholder funds.
5. Off-balance sheet debt of $40mm or 6% of net assets.
6. Outstanding stock option liability of $13mm or 1% of current market value.
RED FLAGS:
1. Misleading Earnings: AKAM reported a $1mm increase in GAAP earnings while our model shows economic earnings declined by $10mm (a difference of $11mm or 7% of reported net income).
2. Very Dangerous Valuation: Stock price of $47 implies AKAM must grow its NOPAT at over 20% com¬pounded annu¬ally for 15 years. A 15-year growth appreciation period with a 20%+ compounding growth rate sets expectations for future cash flow performance quite high.
3. Asset write-offs of $2,000mm or 102% of Net Assets – this means that management has written off at least $1 of assets for every $1 on the current balance sheet. Writing off assets is the opposite of creating shareholder value as it reflects management’s inability to derive any profits for the investments it makes with shareholder funds.
4. Off-balance sheet debt of $128mm or 7% of Net Assets.
5. Outstanding Stock Option Liability of $212mm or 3% of current market value.
The Risk/Reward of the entire Russell 2000 gets our Dangerous Rating. Our recently published Index Benchmark report on the Russell 2000 offers unique insights into the underlying profitability and valuation of all the companies comprised by this index. It also offers benchmarks for (1) investors considering buying ETFs or Index Funds based on the Russell 2000 and for (2) comparing individual stocks to the Russell 2000.
RED FLAGS:
1. Misleading Earnings: RAX reported a $30mm increase in GAAP earnings while our model shows economic earnings declined by $13mm (a difference of $43mm or 7% of revenue).
2. Very Dangerous Valuation: Stock price of $25.636 implies RAX must grow its NOPAT at 25% compounded annually for 17 years. A 17-year Growth Appreciation Period with a 25% compounding growth rate is quite a high standard to beat, as per my post on How To Make Money Picking Stocks.
3. Outstanding Stock Option Liability of $205mm or 6.5% of current market value
RED FLAGS:
Misleading Earnings: CBG reported a $1,045mm increase in GAAP earnings while our model shows economic earnings declined by $358mm.
Very Dangerous Valuation: Stock price of $19.06 implies CBG must grow its NOPAT at 20% compounded annually for 15 years. Has any company ever done that, much less a commercial real estate company?
Rite Aid Corp (RAD) gets a Dangerous Rating because of these RED FLAGs:
1. Very Expensive valuation: current stock price implies the company will grow revenues and NOPAT at 6% compounded annually for the next 15 years while also more than doubling ROIC from 6.1% to 13.7% within the same time frame.
2. Off Balance-Sheet debt: of $5,502mm or 93% of "Reported" Net Assets
3. Asset-write-offs: $3,417mm or 58% of "Reported" Net Assets
Main RED FLAG:
Very Dangerous Valuation: The current stock price of $36.89 implies VMC must grow its NOPAT at 12% compounded annually for 40 years.
The market has set expectations very high for this stock - leaving little upside potential and lots of downside risk, especially when considering the company's Misleading Earnings.
Drugstore.com (DSCM) gets a Dangerous Rating because of these RED FLAGs:
1. Very Expensive valuation: current stock price implies the company will grow revenues at 20% compounded annually for the next 15 years while also improving ROIC from –2.3% to 10.9% within the same time frame.
2. Off Balance-Sheet debt: of $15mm or 15% of Net Assets
3. Asset-write-offs: $210mm or 206% of Net Assets
CBS’s get our Very Dangerous Rating. There is lots of downside risk given the Misleading Earnings and there is little upside reward given the already-rich expectations embedded in the stock price.
RED FLAGS:
1. Misleading Earnings: CBS reported a $11,899mm increase in GAAP earnings while our model shows economic earnings declined by $548mm.
2. Underfunded Pensions of $2,239mm (20% of market value)
3. Asset-write-offs of $10,559mm in asset write-offs (50% of Net Assets and nearly 100% of the market value)
4. High Valuation: market price implies CBS must grow its revenue at 10% compounded annually for 23 years and increase its ROIC from 2.4% to 6% over the same time frame.
icad (ICAD) gets a Dangerous Rating because of these RED FLAGs:
1. Very Expensive valuation: current stock price implies the company will grow revenues at 20% compounded annually for the next 10 years while also improving ROIC from -3.7% to 1.5% within the same time frame.
2. Option Liabilities: of $2.1mm or 3% of the current market value
3. Asset-write-offs: $4.4mm or 7% of Net Assets
The Risk/Reward of investing in Capital One’s stock looks Very Dangerous to me. There is lots of downside risk given the Misleading Earnings and there is little upside reward given the already-rich expectations embedded in the stock price.
RED FLAGS:
1. Misleading Earnings: COF reported a $399mm increase in GAAP earnings while our model shows economic earnings declined by $1,783mm.
2. The company’s ROIC is in the Bottom Quintile of all the companies we cover.
3. Stock price of $40.69 implies COF must grow its NOPAT at 15% compounded annually for 15 years.
David Trainer, Founder & CEO