Caterpillar Inc. (CAT) gets our Dangerous Rating. This means CAT’s quality-of-earnings are not attractive and the stock’s valuation is very expensive. For example, the valuation of the current stock price ($112.16) implies the company will grow its profits at 16% compounded annually for 20 years. The takeaway: there are better stocks to choose from. See details in our free report.
The risk/reward of this stock is quite compelling. Downside risk is low as the valuation already implies a permanent 54% decline in profits. How much worse can the valuation get? Upside reward potential is strong as the stock has to go over $77/share to trade at a value that implies the company’s profits will experience a 0% decline, still a no-growth scenario.
Is VHC the next Google? The market’s current valuation seems to suggest it is that and much more.
Very few times in the last 15 years have I found a stock as expensive as VHC. The only comparable situation that comes to mind is Google (GOOG) at its IPO.
SanDisk Corporation (SNDK) is not getting the credit it deserves for the level of profitability it achieved in 2010. And I am not talking about the accounting profits, but the
Recent weakness in Intel (INTC)'s stock presents an excellent buying opportunity for investors. As one of March’s most attractive, INTC offers the rare combination of strong cash flow growth with a remarkably cheap valuation.
Caterpillar Inc. (CAT) gets our Dangerous Rating. This means CAT's quality-of-earnings are not attractive and the stock's valuation it very expensive.
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 DFS’s current valuation (stock price of $21.80) implies that the company’s profits will decline by 40% and never grow again.
2. Economic earnings are growing faster that reported accounting earnings.
3. Free cash flow of $2.8bn or 24% of its enterprise value during the last fiscal year.
HIDDEN GEM: ABT's current stock price (~$45 per share) implies the company’s profits will permanently decline by 20%. In other words, the market is not only giving no credit for future profit growth, it is predicting a significant (20%) decline in profits.
Of the 561 technology stocks we cover, IDTI is one of the 77 that get our “very dangerous” rating and one of the few that make our most dangerous stocks list for January. The tech sector is tricky because there are several large-cap excellent stocks (MSFT, ADI and AAPL) that make the sector look very good and offer good hiding for some “very dangerous” smaller-cap stocks such as IDTI.
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
Red flags:
1. Misleading earnings: BJRI reported a $3mm increase in GAAP earnings while our model shows economic earnings declined by $2mm (a difference of $5mm or nearly 40% of reported net income) during the last fiscal year.
2. Very dangerous valuation: stock price of $34 implies BJRI must grow its NOPAT at over 20% compounded annually for 15 years. A 15-year growth appreciation period with a 20%+ compounding growth rate sets expectations for future cash flow performance quite high. Historical growth rates are much lower.
3. Free cash flow was -$83mm or -11% of the company’s enterprise value last year.
4. Off-balance sheet debt of $265mm: 79% of net assets and 25% of market value.
5. Outstanding stock option liability of $44mm or 5% of current market value.
We went on record that investors should short SBUX on 11/6/2006 when the stock was close to $38 per share. Click here to see the Fortune Article. The stock did not look attractive to us until 2 years (11/18 – 11/20/08) later when it was under $8, and that for only about 3 days. And ever since we have had a Neutral or Dangerous Rating on the stock.
HIDDEN GEMS:
1. Our discounted cash flow analysis shows that ACN’s current valuation (stock price of $48.59) implies that the company’s profits will decline by 9% and never grow again.
2. Economic earnings are higher than reported accounting earnings.
3. Excess cash of $3,728mm or about 12% of its market cap
RED FLAGS:
1. Misleading earnings: DFS reported a $295mm increase in GAAP earnings while our model shows economic earnings declined by $998mm (a difference of $1,293mm or over 100% of reported net income). The majority of the overstated reported earnings comes from a one-time gain from an anti-trust settlement of $1,892mm.
2. Very dangerous valuation: stock price of $19 implies DFS must grow its NOPAT at over 10% compounded annually for 40 years. A 40-year growth appreciation period with a 10%+ compounding growth rate sets expectations for future cash flow performance quite high. Historical growth rates have never been much lower.
3. Free Cash Flow was -$2,470mm or -26% of the company’s enterprise value last year.
4. Asset write-offs of $428mm or 5% of net assets – this means that management has written off at least $0.05 of assets for every $1 on the current balance sheet. Writing off assets is the opposite of creating shareholder value as it reflects management’s inability to derive any profits for the investments it makes with shareholder funds.
5. Off-balance sheet debt of $38mm or 0.5% of net assets.
6. Outstanding stock option liability of $8mm or less than 1% of current market value.
HIDDEN GEMS:
1. About $15 million in non-operating expenses (after-tax) cause reported earnings to be understated.
2. Our discounted cash flow analysis shows that ADI’s current valuation (stock price of $37.18) implies that the company’s profits will decline by 10% and never grow again.
3. The company grew its economic earnings by $283mm during its last fiscal year.
4. Excess cash of $2,462.5mm or nearly 25% of its market cap
The December version of our Most Attractive Stocks report is now available. Note that Barron’s recently recognized our Most Attractive Stocks portfolio as #1 over the prior 12 months amongst
Red Flags:
1. Misleading earnings: JDAS reported a $14.6mm increase in GAAP earnings while our model shows economic earnings declined by $12.9mm (a difference of $27.5mm or 155% of reported net income).
2. Very dangerous valuation: stock price of $27 implies JDAS must grow its NOPAT at over 20% compounded annually for 10 years. A 10-year growth appreciation period with a 20%+ compounding growth rate sets expectations for future cash flow performance quite high.
3. Free Cash Flow was -$203mm or -15% of the company’s enterprise value last year.
4. Asset write-offs of $21mm or 3% of net assets – this means that management has written off at least $0.03 of assets for every $1 on the current balance sheet. Writing off assets is the opposite of creating shareholder value as it reflects management’s inability to derive any profits for the investments it makes with shareholder funds.
5. Off-balance sheet debt of $40mm or 6% of net assets.
6. Outstanding stock option liability of $13mm or 1% of current market value.
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.
David Trainer, Founder & CEO