Recap from November’s Picks
Our Most Attractive Stocks (-0.3%) underperformed the S&P 500 (+1.2%) from November 6, 2019 through December 2, 2019. The best performing large cap stock gained 13% and the best performing small cap stock was up 12%. Overall, 15 out of the 40 Most Attractive stocks outperformed the S&P 500.
Our Most Dangerous Stocks (-0.4%) outperformed the S&P 500 (+1.2%) as a short portfolio from November 6, 2019 through December 2, 2019. The best performing large cap stock fell by 12% and the best performing small cap stock fell by 16%. Overall, 26 out of the 40 Most Dangerous stocks outperformed the S&P 500 as shorts.
Only our research utilizes the superior data and earnings adjustments featured by the HBS & MIT Sloan paper, “Core Earnings: New Data and Evidence.” The successes of these model portfolios highlight the value of our machine learning and AI Robo-Analyst technology[1], which helps clients fulfill the fiduciary duty of care and make smarter investments[2].
14 new stocks make our Most Attractive list this month, and 15 new stocks fall onto the Most Dangerous list this month. December’s Most Attractive and Most Dangerous stocks were made available to members on December 4, 2019.
Our Most Attractive stocks have high and rising returns on invested capital (ROIC) and low price to economic book value ratios. Most Dangerous stocks have misleading earnings and long growth appreciation periods implied by their market valuations.
Most Attractive Stocks Feature for December: C.H. Robinson Worldwide
C.H. Robinson Worldwide (CHRW) is the featured stock from December’s Most Attractive Stocks Model Portfolio.
Over the past decade, CHRW has grown after-tax profit (NOPAT) by 6% compounded annually. CHRW’s trailing twelve month (TTM) NOPAT is up 12% over the prior TTM period as well. CHRW’s NOPAT margin has averaged 4% over the past decade and is 4.4% over the TTM period. After declining during 2015-2017, CHRW’s return on invested capital (ROIC) improved from 17% in 2017 to 21% TTM.
Figure 1: CHRW’s Revenue & NOPAT Since 2008
Image Source: New Constructs, LLC
Sources: New Constructs, LLC and company filings
CHRW Valuation Offers Upside Potential
At its current price of $76/share, CHRW has a price-to-economic book value (PEBV) ratio of 1.0. This ratio means the market expects CHRW’s NOPAT to never meaningfully grow from current levels. This expectation seems overly pessimistic for a firm that has grown NOPAT by 6% compounded annually over the past decade and 15% compounded annually over the past two decades.
If CHRW can maintain its TTM NOPAT margin (4.4%) and grow NOPAT by just 4% compounded annually for the next decade, the stock is worth $101/share today – a 33% upside. See the math behind this reverse DCF scenario.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
As investors focus more on fundamental research, research automation technology is needed to analyze all the critical financial details in financial filings as shown in the Harvard Business School and MIT Sloan paper, “Core Earnings: New Data and Evidence”.
Below are specifics on the adjustments we make based on Robo-Analyst findings in C.H. Robinson’s 2018 10-K:
Income Statement: we made $95 million of adjustments, with a net effect of removing $9 million in non-operating income (<1% of revenue). You can see all the adjustments made to CHRW’s income statement here.
Balance Sheet: we made $359 million of adjustments to calculate invested capital with a net increase of $264 million. One of the largest adjustments was $219 million in operating leases. This adjustment represented 7% of reported net assets. You can see all the adjustments made to CHRW’s balance sheet here.
Valuation: we made $1.6 billion of adjustments with a net effect of decreasing shareholder value by $1.6 billion. There were no adjustments that increased shareholder value. Apart from total debt, which includes the operating leases noted above, the largest adjustment to shareholder value was $104 million in outstanding employee stock options. This adjustment represents 1% of CHRW’s market cap. See all adjustments to CHRW’s valuation here.
Most Dangerous Stocks Feature: Heska Corporation
Heska Corporation (HSKA) is the featured stock from December’s Most Dangerous Stocks Model Portfolio.
HSKA’s NOPAT has declined from $14 million in 2017 to just $4 million TTM, per Figure 2. HSKA’s NOPAT margin has fallen from 11% in 2017 to 3% TTM while ROIC fell from 13% to 3% over the same time.
Figure 2: HSKA’s NOPAT Since 2017
Image Source: New Constructs, LLC
Sources: New Constructs, LLC and company filings
HSKA Provides Poor Risk/Reward
Despite its deteriorating fundamentals, HSKA is still priced for significant profit growth.
To justify its current price of $95/share, HSKA must achieve 2018 NOPAT margins of 7% (compared to 3% TTM) and grow NOPAT by 15% compounded annually for the next 14 years. See the math behind this reverse DCF scenario. This expectation seems overly optimistic given that HSKA’s NOPAT and margins have fallen precipitously in the last two years.
Even if we assume HSKA can achieve a 7% NOPAT margin and grow NOPAT by 8%compounded annually for the next decade, the stock is worth only $33/share today – a 65% downside. See the math behind this reverse DCF scenario.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
As investors focus more on fundamental research, research automation technology is needed to analyze all the critical financial details in financial filings as shown in the Harvard Business School and MIT Sloan paper, “Core Earnings: New Data and Evidence”.
Below are specifics on the adjustments we make based on Robo-Analyst findings in Heska Corporation’s 2018 10-K:
Income Statement: we made $13 million of adjustments, with a net effect of removing $3 million in non-operating expense (2% of revenue). You can see all the adjustments made to HSKA’s income statement here.
Balance Sheet: we made $60 million of adjustments to calculate invested capital with a net decrease of $7 million. One of the largest adjustments was $14 million due to deferred tax assets. This adjustment represented 10% of reported net assets. You can see all the adjustments made to HSKA’s balance sheet here.
Valuation: we made $161 million of adjustments with a net effect of decreasing shareholder value by $12 million. The largest adjustment to shareholder value was $74 million in excess cash. This adjustment represents 10% of HSKA’s market cap. See all adjustments to HSKA’s valuation here.
This article originally published on December 11, 2019.
Disclosure: David Trainer, Kyle Guske II, and Sam McBride receive no compensation to write about any specific stock, style, or theme.
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[1] Harvard Business School features the powerful impact of our research automation technology in the case New Constructs: Disrupting Fundamental Analysis with Robo-Analysts.
[2] This paper compares our analytics on a mega cap company to other major providers. The Appendix details exactly how we stack up.
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