We closed this position on August 11, 2015. A copy of the associated Position Update report is here.

CB Richard Ellis Group, Inc. (CBG) is one of October’s Most Dan­ger­ous Stocks. Free copy of report is here: CBG. And like all of our Most Dan­ger­ous Stocks the company has:

1. Mis­lead­ing earn­ings = account­ing prof­its are pos­i­tive and ris­ing while true, eco­nomic prof­its are neg­a­tive and falling
2. High Val­u­a­tion = very high expec­ta­tions embed­ded in the cur­rent valuation.

RED FLAGS:

1. Mis­lead­ing Earn­ings: CBG reported a $1,045mm increase in GAAP earn­ings while our model shows eco­nomic earn­ings declined by $358mm (a difference of $1,403mm or 34% of revenue). The main dri­vers of the dif­fer­ence between Eco­nomic ver­sus Account­ing earn­ings are CBG’s’s (a) $1,208mm in asset write-offs — 30% of Net Assets and (b) $675mm of off-balance sheet debt — 17% of Net Assets.
2. Very Dan­ger­ous Val­u­a­tion: Stock price of $19.06 implies CBG must grow its NOPAT at 20% com­pounded annu­ally for 15 years. A 15-year Growth Appre­ci­a­tion Period with a 20% com­pound­ing growth rate is quite a high stan­dard to beat, as per my post on How To Make Money Pick­ing Stocks.
3. Asset write-offs of $1,209 million (30% of reported net assets – 30cents of every $1 invested in the business over its life)
4. Stock option lia­bil­i­ties of $80mm (1% of mar­ket value)

Over­all, the Risk/Reward of invest­ing in CBG’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.

See Appen­dix 4 to learn how CBG’s NOPAT declined versus last year while though Net Income rose. See Appen­dix 5 for details on CBG’s Invested Cap­i­tal. Appen­dix 7 (in the Return on Invested Cap­i­tal sec­tion) shows how a rising NOPAT Mar­gin but falling Invested Cap­i­tal Turns result in a decrease in ROIC (from 3.4% to 3.2%) and Eco­nomic Profit, which fell by $358mm while Net Income rose by $1,045mm.

As per Invest­ment Strat­egy 101 and How to make money pick­ing stocks, CBG fits the pro­file of a great stock to short or sell.

See Finance 101 and Eco­nomic Ver­sus Account­ing Prof­its for more detail on why account­ing prof­its are not reli­able indi­ca­tors of cor­po­rate prof­itabil­ity or value creation.

Note: Stock pick of the week is updated every Tuesday.