April Performance Recap
Our Most Attractive Stocks (+1.6%) outperformed the S&P 500 (-7.3%) from April 6, 2022 through May 2, 2022 by 8.9%. The best performing large cap stock gained 21% and the best performing small cap stock was up 19%. Overall, 34 out of the 40 Most Attractive stocks outperformed the S&P 500.
Our Most Dangerous Stocks (-7.8%) outperformed the S&P 500 (-7.3%) as a short portfolio from April 6, 2022 through May 2, 2022 by 0.5%. The best performing large cap short stock fell by 19%, and the best performing small cap short stock fell by 27%. Overall, 17 out of the 35 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 9.4%.
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.
Ten new stocks made our Most Attractive list this month, and ten new stocks also fell onto the Most Dangerous list. May’s Most Attractive and Most Dangerous stocks were made available to members on May 4, 2022.
Our Most Attractive stocks all 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 May: Mueller Industries, Inc. (MLI: $53/share)
Mueller Industries, Inc. (MLI) is the featured stock from May’s Most Attractive Stocks Model Portfolio.
Before the COVID-19 pandemic, Mueller Industries grew revenue by 5% compounded annually and net operating profit after-tax (NOPAT) by 6% compounded annually from 2009 to 2019. Since 2019, the company’s NOPAT margin has increased from 5% to 14% over the trailing twelve months (TTM), while ROIC improved from 9% to 34% over the same time.
Figure 1: Revenue & NOPAT Since 2009
Sources: New Constructs, LLC and company filings
Mueller Industries Is Undervalued
At its current price of $53/share, MLI has a price-to-economic book value (PEBV) ratio of 0.4. This ratio means the market expects Mueller Industries’ NOPAT to permanently decline by 60%. This expectation seems overly pessimistic for a company that grew NOPAT by 6% compounded annually from 2009 to 2019 before the COVID-19 pandemic.
Even if Mueller Industries’ NOPAT margin falls to 7% (equal to five-year average, compared to 14% TTM) and the company’s NOPAT declines by 4% compounded annually for the next decade, the stock is worth $67/share today – a 26% upside. See the math behind this reverse DCF scenario. Should Mueller Industries 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 Mueller Industries’ 10-Qs and 10-K:
Income Statement: we made $138 million in adjustments, with a net effect of removing $15 million in non-operating expense (<1% of revenue). Clients can see all adjustments made to Mueller Industries’ income statement on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: we made $421 million in adjustments to calculate invested capital with a net increase of $191 million. One of the most notable adjustments was $169 million related to total reserves. This adjustment represented 13% of reported net assets. Clients can see all adjustments made to Mueller Industries’ balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: we made $100 million of adjustments, all of which decreased shareholder value. One of the most notable adjustments to shareholder value was $36 million in minority interests. This adjustment represents 1% of Mueller Industries’ market cap. Clients can see all adjustments to Mueller Industries’ valuation on the GAAP Reconciliation tab on the Ratings page on our website.
Most Dangerous Stocks Feature: Raytheon Technologies Corp (RTX: $91/share)
Raytheon Technologies Corp (RTX) is the featured stock from May’s Most Dangerous Stocks Model Portfolio.
Raytheon’s economic earnings, the true cash flows of the business, have fallen from $1.5 billion in 2016 to -$8.1 billion over the TTM. The company’s NOPAT margin has fallen from 10% to -1%, while invested capital turns fell from 0.8 to 0.5 over the same time. Falling NOPAT margins and invested capital turns drive Raytheon’s ROIC from 8% in 2016 to -0.4% TTM.
Figure 2: Economic Earnings Since 2016
Sources: New Constructs, LLC and company filings
Raytheon Provides Poor Risk/Reward
Despite its poor fundamentals, Raytheon is priced for significant profit growth, and we believe the stock is overvalued.
To justify its current price of $91/share, Raytheon must improve its NOPAT margin to 11% (all-time high in 2013, compared to -1% 2021) and grow revenue by 6% compounded annually for the next decade. See the math behind this reverse DCF scenario. In this scenario, Raytheon grows NOPAT by 11% compounded annually over the next ten years. Given that Raytheon’s NOPAT fell 7% compounded annually over the past five years and fell 3% compounded annually over the past decade, we think these expectations look overly optimistic.
Even if Raytheon can achieve a NOPAT margin of 7% (three-year average) and grow revenue by 6% compounded annually for the next decade, the stock is worth just $46/share today – a 49% downside to the current stock price. See the math behind this reverse DCF scenario. Should Raytheon’s revenue grow at a slower rate, the stock has even more downside.
Each of these scenarios also assumes Raytheon can grow revenue, NOPAT, and FCF without increasing working capital or fixed assets. This assumption is unlikely but allows us to create truly 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 Raytheon’s 10-Qs and 10-K:
Income Statement: we made $5.1 billion in adjustments, with a net effect of removing $331 million in non-operating expenses (<1% of revenue). Clients can see all adjustments made to Raytheon’s income statement on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: we made $19.9 billion in adjustments to calculate invested capital with a net increase of $53 million. One of the most notable adjustments was $4.3 billion in deferred tax assets. This adjustment represented 3% of reported net assets. Clients can see all adjustments made to Raytheon’s balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: we made $49.6 billion in adjustments, with a net decrease to shareholder value of $44.1 billion. Apart from total debt, the most notable adjustment to shareholder value was $5 billion in net deferred tax liabilities, which include the deferred mentioned above. This adjustment represents 4% of Raytheon’s market cap. Clients can see all adjustments to Raytheon’s valuation on the GAAP Reconciliation tab on the Ratings page on our website.
This article originally published on May 13, 2022.
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] Our research utilizes our Core Earnings, a more reliable measure of profits, as proven in Core Earnings: New Data & Evidence, written by professors at Harvard Business School (HBS) & MIT Sloan and published in The Journal of Financial Economics.