This week we have two featured stock picks, one from our Most Attractive Stocks and one from our Most Dangerous Stocks Model Portfolios.
As the market continues to reach new highs, finding stocks that could blow up a portfolio could be just as important as finding stocks that remain undervalued.
These featured stock reports provide a concise summary of how we pick stocks for these Model Portfolios. They are not full Long Idea or Danger Zone reports, but they give you insight into the rigor of our research and approach to picking stocks. Whether you’re a subscriber or not, we think it is important that you’re able to see our research on stocks on a regular basis. We’re proud to share our work.
We’re not giving you the names of the stocks featured, because they are only available to our Pro and Institutional members. But, there’s still so much to see here. We want you to see how much work we do; so you know where to set the bar when evaluating research providers.
We hope you enjoy this research. Feel free to share with friends and colleagues.
We update these Model Portfolios monthly and September’s Most Attractive and Most Dangerous Stocks Model Portfolios were updated and published for clients on October 3, 2024.
September Performance Recap
In the Most Attractive Stocks Model Portfolio, the best performing large cap stock gained 13% and the best performing small cap stock was up 53%. Overall, 15 out of the 38 Most Attractive stocks outperformed the S&P 500.
In the Most Dangerous Stocks Model Portfolio, the best performing large cap short stock fell by 12% and the best performing small cap short stock fell by 10%. Overall, 21 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 October: Consumer Cyclicals Company
This company has grown revenue and net operating profit after tax (NOPAT) by 12% and 22% compounded annually since 2013, respectively. The company’s NOPAT margin increased from 2% in 2013 to 6% in the TTM and invested capital turns rose from 1.8 to 2.5 over the same time. Rising NOPAT margins and invested capital turns drive return on invested capital (ROIC) from 4% in 2013 to 15% 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 $63/share, this stock has a price-to-economic book value (PEBV) ratio of 0.7. This ratio means the market expects the company’s NOPAT to permanently decline by 30%. This expectation seems overly pessimistic for a company that has grown NOPAT by 22% compounded annually since 2013 and 15% compounded annually since 2018.
Even if the company’s NOPAT margin falls to 4% (below TTM NOPAT margin of 6%) and revenue grows just 7% (below ten-year compound annual growth rate of 12%) compounded annually through 2033, the stock would be worth $75/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 made around $10 million in adjustments, with a net effect of removing over $3 million in non-operating expenses. 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 $130 million in adjustments to calculate invested capital with a net increase of around $70 million. One of the most notable adjustments was for asset write downs. 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 around $75 million in adjustments all of which decreased shareholder value. Apart from total debt, the most notable adjustment was for deferred tax liabilities. Professional members can see all adjustments to valuations on the GAAP Reconciliation tab on the Ratings page on our website.
Most Dangerous Stocks Feature: Financials Company
This company’s NOPAT margin fell from 24% in 2018 to 3% in the TTM while invested capital turns remained still at 0.3 over the same time. Falling NOPAT margins down the company’s ROIC from 7% in 2018 to 1% 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 -$16 million in 2018 to -$584 million in the TTM. Meanwhile GAAP net income has risen from $221 million to $573 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 $31/share, the company must improve its NOPAT margin to 17% (above TTM NOPAT margin of 3%) and grow revenue by 5% compounded annually through 2033. In this scenario, the company grows NOPAT 31% compounded annually to $579 million in 2033. We think these expectations are overly optimistic, especially considering the company’s NOPAT fell 19% compounded annually over the past five years.
Even if the company improves its NOPAT margin to 10% (above TTM NOPAT margin of 3%) and grows revenue 5% compounded annually through 2033, the stock would be worth no more than $18/share today – a 42% downside to the current stock price.
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 just under $650 million in adjustments, with a net effect of removing under $500 million in non-operating income. 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 $2.3 billion in adjustments to calculate invested capital with a net increase of over $1.0 billion. One of the most notable adjustments was over one billion in other comprehensive income. 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 $400 million in adjustments to shareholder value with a net decrease of just under $250 million. 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.
…there’s much more in the full report. You can start your membership here or login above to get access to this report and much more.