We closed this position on August 6, 2015. A copy of the associated Position Update report is here.
CBS Class B Shares (CBS) is one of September’s Most Dangerous Stocks. Free copy of report is here: CBS. And like all of our Most Dangerous Stocks the company has:
- Misleading earnings = accounting profits are positive and rising while true, economic profits are negative and falling
- High Valuation = very high expectations embedded in the current valuation.
RED FLAGS:
- Misleading Earnings: CBS reported a $11,899mm increase in GAAP earnings while our model shows economic earnings declined by $548mm. The main drivers of the difference between Economic versus Accounting earnings are CBS’s (a) $10,559mm in asset write-offs – 50% of Net Assets and (b) $1,824mm of off-balance sheet debt – 8% of Net Assets.
- Stock price of $15.71 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. A 23-year Growth Appreciation Period with 10% compounding growth rate is quite a high standard to beat, as per my post on How To Make Money Picking Stocks.
- Underfunded Pensions of $2,239mm (20% of market value)
Overall, the Risk/Reward of investing in CBS’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 CBS NOPAT plummeted even though Net Income rose in its last fiscal year based on a big decrease in non-operating expenses versus the prior year. See Appendix 5 for details on CBS’s Invested Capital. Appendix 7 (in the Return on Invested Capital section) shows how the falling NOPAT Margin and flat Invested Capital Turns result in a decrease in ROIC (to 2.4% from 4.4%) and Economic Profit, which fell by $548n while Net Income rose by $11,899mm.
As per Investment Strategy 101 and How to make money picking stocks, CBS 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.