Recap From November’s Picks
Our Most Attractive Stocks (-3.8%) underperformed the S&P 500 (-2.0%) from November 3, 2021 through November 30, 2021 by 1.8%. The best performing large cap stock gained 1% and the best performing small cap stock was up 24%. Overall, 14 out of the 40 Most Attractive stocks outperformed the S&P 500.
Our Most Dangerous Stocks (-9.6%) outperformed the S&P 500 (-2.0%) as a short portfolio from November 3, 2021 through November 30, 2021 by 7.6%. The best performing large cap short stock fell by 51% and the best performing small cap short stock fell by 28%. Overall, 31 out of the 39 Most Dangerous stocks outperformed the S&P 500 as shorts.
The Most Attractive/Most Dangerous Model Portfolios outperformed as an equal-weighted long/short portfolio by 2.9%.
More reliable & proprietary fundamental data, proven in The Journal of Financial Economics, drives our research and provides investors with a new source of alpha. Our proprietary Robo-Analyst Technology[1] scales our forensic accounting expertise (featured in Barron's ) across thousands of stocks[2] to produce an unrivaled database of fundamental data.
Eleven new stocks make our Most Attractive list this month, and seventeen new stocks fall onto the Most Dangerous list this month. December’s Most Attractive and Most Dangerous stocks were made available to members on December 2, 2021.
Our Most Attractive stocks all share a 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 December: Zions Bancorporation (ZION: $64/share)
Zions Bancorporation is the featured stock from December’s Most Attractive Stocks Model Portfolio.
Zions has grown revenue by 10% compounded annually and net operating profit after-tax (NOPAT) by 33% compounded annually over the past five years.
The company’s NOPAT margin increased from 14% in 2015 to 39% over the trailing twelve months (TTM), while invested capital turns rose from 0.2 to 0.3 over the same period. Rising margins and improved invested capital turns drove Zions’ ROIC from 3% in 2015 to 12% over the TTM.
Zions generated $3.6 billion (36% of market cap) in cumulative free cash flow (FCF) over the past five years, and $1.3 billion in FCF over the TTM.
Figure 1: Revenue & NOPAT Since 2015
Sources: New Constructs, LLC and company filings
Zions Is Undervalued
At its current price of $64/share, ZION has a price-to-economic book value (PEBV) ratio of 0.4. This ratio means the market expects Zions’ NOPAT to permanently decline by 60%. This expectation seems overly pessimistic for a company that has grown NOPAT by 10% compounded annually over the past two decades.
Even if Zions’ NOPAT margin falls to 27% (equal to five-year average, compared to 39% TTM) and the company’s NOPAT grows by <1% compounded annually for the next decade, the stock is worth $140/share today – a 119% upside. See the math behind this reverse DCF scenario. Should Zions grow profits more in line with historical levels, the stock has even more upside.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
Below are specifics on the adjustments we make based on Robo-Analyst findings in Zions’ 10-K and 10-Qs:
Income Statement: we made $483 million in adjustments, with a net effect of removing $279 million in non-operating expenses (8% of revenue). You can see all the adjustments made to Zions’ income statement here.
Valuation: we made $821 million of adjustments with a net effect of decreasing shareholder value by $581 million. One of the most notable adjustments to shareholder value was $440 million in preferred stock. This adjustment represents 4% of Zions’ market cap. See all adjustments to Zions’ valuation here.
Balance Sheet: we made $3.3 billion in adjustments to calculate invested capital with a net increase of $1.7 billion. One of the most notable adjustments was $1.2 billion in asset write-downs. This adjustment represented 14% of reported net assets. You can see all the adjustments made to Zions’ balance sheet here.
Most Dangerous Stocks Feature: Stericycle Inc. (SRCL: $58/share)
Stericycle Inc. (SRCL) is the featured stock from December’s Most Dangerous Stocks Model Portfolio.
Stericycle’s economic earnings, the true cash flows of the business, fell from $173 million in 2015 to -$238 million over the TTM. The company’s NOPAT margin fell from 15% in 2015 to 2% TTM, while invested capital turns fell from 0.6 to 0.4 over the same time. Falling NOPAT margins and invested capital turns drove Stericycle’s ROIC from 9% in 2015 to 1% over the TTM.
Figure 2: Economic Earnings Since 2015
Sources: New Constructs, LLC and company filings
Stericycle Provides Poor Risk/Reward
Despite its poor fundamentals, Stericycle is priced for significant profit growth, and we believe the stock is overvalued.
To justify its current price of $58/share, Stericycle must improve its NOPAT margin to 8% (three-year average compared to 2% TTM) and grow NOPAT by 9% compounded annually for the next decade. See the math behind this reverse DCF scenario. Given that Stericycle’s NOPAT fell 18% compounded annually since 2015, we think these expectations are overly optimistic.
Even if Stericycle can achieve a NOPAT margin of 8% and grow NOPAT by 5% compounded annually for the next decade, the stock is worth just $32/share today – a 45% downside to the current stock price. See the math behind this reverse DCF scenario. Should Stericycle’s NOPAT grow at a slower rate or, even worse, continue its downward trend, the stock has even more downside.
Each of these scenarios also assumes Stericycle is able to grow revenue, NOPAT, and FCF without increasing working capital or fixed assets. This assumption is unlikely but allows us to create best-case scenarios that demonstrate how high expectations embedded in the current valuation are.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
Below are specifics on the adjustments we make based on Robo-Analyst findings in Stericycle’s 10-K and 10-Qs:
Income Statement: we made $316 million in adjustments, with a net effect of removing $226 million in in non-operating expenses (8% of revenue). You can see all the adjustments made to Stericycle’s income statement here.
Balance Sheet: we made $2.4 billion in adjustments to calculate invested capital with a net increase of $1.6 billion. One of the most notable adjustments was $926 million in asset write-downs. This adjustment represented 19% of reported net assets. You can see all the adjustments made to Stericycle’s balance sheet here.
Valuation: we made $2.5 billion in adjustments, all of which decreased shareholder value. Apart from total debt, The most notable adjustment to shareholder value was $374 million in deferred tax liabilities. This adjustment represents 7% of Stericycle’s market cap. See all adjustments to Stericycle’s valuation here.
This article originally published on December 10, 2021.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
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[1] Harvard Business School features our research automation technology in the case Disrupting Fundamental Analysis with Robo-Analysts.
[2] See how our models overcome flaws in Bloomberg and Capital IQ’s (SPGI) analytics in the detailed appendix of this paper.