Over the past 10 years, ARBA appears as quite a success story and one of the few ‘internet bubble’ companies to survive and reach profitability, on a GAAP accounting basis at least. Looking beyond the reported accounting results, however, reveals that ARBA is not quite as profitable a company as it seems, and its valuation has out-grown its profits by a wide margin – the required combination of factors for making February’s list of most dangerous stocks.
HIDDEN GEMS:
1. Our discounted cash flow analysis shows that APOL’s current valuation (stock price of $42.31) implies that the company’s profits will decline by 60% and never grow again.
2. Economic earnings are higher than reported accounting earnings.
3. Excess cash of $1,201mm or about 20% of its market cap
HIDDEN GEMS:
1. About $29 million in non-operating expenses (after-tax) cause reported earnings to be understated.
2. Our dis¬counted cash flow analy¬sis shows that TRV’s cur¬rent val¬u¬a¬tion (stock price of $55.49) implies that the company’s profits will decline by 30% and never grow again.
3. The company grew its economic earn¬ings by $827mm during its last fiscal year.
HIDDEN GEM: Our detailed valuation model shows that WDC grew its “economic” profits by 226% while accounting profits grew 194% during its last fiscal year. Economic profits rose by $769mm while accounting profits rose by $912mm.
RED FLAGS:
1. Misleading Earnings: RAX reported a $30mm increase in GAAP earnings while our model shows economic earnings declined by $13mm (a difference of $43mm or 7% of revenue).
2. Very Dangerous Valuation: Stock price of $25.636 implies RAX must grow its NOPAT at 25% compounded annually for 17 years. A 17-year Growth Appreciation Period with a 25% compounding growth rate is quite a high standard to beat, as per my post on How To Make Money Picking Stocks.
3. Outstanding Stock Option Liability of $205mm or 6.5% of current market value
HIDDEN GEMS:
1. Our discounted cash flow analysis shows that BMY’s current valuation (stock price of $27.16) implies that the company’s profits will decline by 35% and never grow again.
2. The company grew its economic earnings by $307.5mm (12% increase) during its last fiscal year.
3. The company has $9,507mm in Excess Cash, which we remove from our Invested Capital calculation. $9,507mm million is more than 20% of BMY’s market cap.
HIDDEN GEM: AAPL's economic earnings rose more than its accounting earnings during the last fiscal year. Economic earnings rose by $3,576 while accounting earnings rose by $2,401. And the company has $31,849mm in Excess Cash, a reflection of the strong profitability of the business.
RED FLAGS:
Misleading Earnings: CBG reported a $1,045mm increase in GAAP earnings while our model shows economic earnings declined by $358mm.
Very Dangerous Valuation: Stock price of $19.06 implies CBG must grow its NOPAT at 20% compounded annually for 15 years. Has any company ever done that, much less a commercial real estate company?
HIDDEN GEM: GOOG has over $24,100mm in Excess Cash, a reflection of the profitability of the business and a 64% deduction to Reported Net Assets for our Invested Capital calculation.
At a time when most of the public believes political leadership to be weak, we should not focus on finding scapegoats but rather on assuming accountability to help fix problems.
HIDDEN GEMS:
1. Our discounted cash flow analysis shows that WNI’s current valuation (stock price of $7.89) implies that the company’s profits will decline by 25% and never grow again.
2. The company grew its economic earnings more than its reported earnings. Economic earnings rose by $9.1mm (506% increase) while Net Income rose by only $8.1mm (79% increase) during its last fiscal year.
3. The company has $42mm in Excess Cash, which we remove from our Invested Capital calculation. $42 million is 20% of WNI’s market cap.
Main RED FLAG:
Very Dangerous Valuation: The current stock price of $36.89 implies VMC must grow its NOPAT at 12% compounded annually for 40 years.
The market has set expectations very high for this stock - leaving little upside potential and lots of downside risk, especially when considering the company's Misleading Earnings.
HIDDEN GEMS:
1. Our discounted cash flow analysis shows that MSFT’s current valuation (stock price of $24.73) implies that the company’s profits will decline by 20% and never grow again.
2. The company has $43,292mm in Excess Cash (over 20% of the market cap), which we remove from our Invested Capital calculation and which helps drive a whopping 61.6% ROIC.
3. Our economic earnings models shows profits are growing, not declining, which makes the Risk/Reward for MSFT Very Attractive.
CBS’s get our Very Dangerous Rating. 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.
RED FLAGS:
1. Misleading Earnings: CBS reported a $11,899mm increase in GAAP earnings while our model shows economic earnings declined by $548mm.
2. Underfunded Pensions of $2,239mm (20% of market value)
3. Asset-write-offs of $10,559mm in asset write-offs (50% of Net Assets and nearly 100% of the market value)
4. High Valuation: market price 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.
icad (ICAD) gets a Dangerous Rating because of these RED FLAGs:
1. Very Expensive valuation: current stock price implies the company will grow revenues at 20% compounded annually for the next 10 years while also improving ROIC from -3.7% to 1.5% within the same time frame.
2. Option Liabilities: of $2.1mm or 3% of the current market value
3. Asset-write-offs: $4.4mm or 7% of Net Assets
HIDDEN GEM: Our detailed discounted cash flow analysis shows that STX’s current valuation (stock price of $11.24) implies that the company’s profits will decline by 80% and never grow again. Our economic earnings model shows profits are growing, not declining, which makes the Risk/Reward for STX Very Attractive.
The Risk/Reward of investing in Capital One’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.
RED FLAGS:
1. Misleading Earnings: COF reported a $399mm increase in GAAP earnings while our model shows economic earnings declined by $1,783mm.
2. The company’s ROIC is in the Bottom Quintile of all the companies we cover.
3. Stock price of $40.69 implies COF must grow its NOPAT at 15% compounded annually for 15 years.
Dangerous Rating with several RED FLAGS. See my recent post Mayo Is Right about Citi for details on our analysis of the company's loose Deferred Tax accounting and other Red Flags. There are other reasons to run from this stock.
RED FLAGS:
Over $7bn in off-balance sheet debt
$2.2bn in under-funded Pension liabilities
Over $10bn in Asset write-offs
Very Dangerous valuation (detail follow)
I believe that most of the traders and speculators who have been successful enough to stay afloat will be forced to exit the business or shift to a value investment style - an endeavor in which I expect very, very few to be successful. And though there will be fewer speculators, enough will remain to keep the markets from being too efficient.