Featured Stocks in Our Most Attractive/Most Dangerous Model Portfolios

David Trainer  |


Recap from June’s Picks

Our Most Attractive Stocks (-2.9%) underperformed the S&P 500 (-1.9%) last month. Most Attractive Large Cap stock Kellogg Company  (K) gained 11%. Most Attractive Small Cap stock Value Line  (VALU) was up 18%. Overall, 19 out of the 40 Most Attractive stocks outperformed the S&P 500 in June.

Our Most Dangerous Stocks (-1.1%) underperformed the S&P 500 (-1.9%) as a short portfolio last month. Most Dangerous Large Cap stock Blackberry, Ltd  (BB) fell by 23% and Most Dangerous Small Cap Stock Monotype Imaging Holdings  (TYPE) fell by 10%. Overall, 19 out of the 40 Most Dangerous stocks outperformed the S&P 500 as shorts in June.

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].

12 new stocks make our Most Attractive list this month and five new stocks fall onto the Most Dangerous list this month. July’s Most Attractive and Most Dangerous stocks were made available to members on July 3, 2018.

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.

MKS Instruments  (MKSI), a provider of technical instruments that measure, control, power, deliver, monitor, and analyze manufacturing processes, is the featured stock from July’s Most Attractive Stocks Model Portfolio.

Since 2013, MKSI has grown after-tax profit (NOPAT) by 59% compounded annually, from $53 million in 2013 to $340 million in 2017. MKSI has continued to grow profits in 2018, and it’s NOPAT is $377 million over the trailing twelve months (TTM). The company’s NOPAT margin has risen from 8% in 2013 to 19% TTM while its return on invested capital (ROIC) has improved from 6% to 16%.

Figure 1: MKSI’s Revenue & NOPAT Since 2013

Sources: New Constructs, LLC and company filings

MKSI has significantly outperformed the S&P 500 over the past five years (+250% vs. +66%), but the stock remains undervalued. At its current price of $97/share, MKSI has a price-to-economic book value (PEBV) ratio of 1.1. This ratio implies that the market expects MKSI’s NOPAT to grow by no more than 10% over the remaining life of the corporation. This expectation seems rather pessimistic for a company that has grown NOPAT by 18% compounded annually since 1999.

If MKSI can maintain current margins (19%) and grow NOPAT by just 7% compounded annually for the next decade, the stock is worth $116/share today – a 20% upside. See the math behind this dynamic DCF scenario.

As investors focus more on fundamental research, research automation technology is needed to analyze all the critical financial details in financial filings. Below are specifics on the adjustments we make based on Robo-Analyst findings in MKS Instruments’ 2017 10-K:

Income Statement: we made $157 million of adjustments, with a net effect of removing $1 million in non-operating expense (<1% of revenue). We removed $78 million in non-operating income and $79 million in non-operating expenses. You can see all the adjustments made to MKSI’s income statement here.

Balance Sheet: we made $1.2 billion of adjustments to calculate invested capital with a net increase of $111 million. One of the largest adjustments was $299 million due to asset write-downs. This adjustment represented 14% of reported net assets. You can see all the adjustments made to MKSI’s balance sheet here.



Valuation: we made $961 million of adjustments with a net effect of decreasing shareholder value by $60 million. The largest adjustment to shareholder value was $451 million in excess cash. This adjustment represents 8% of MKSI’s market cap.

IQVIA Holdings  (IQV), a healthcare data analysis and clinical trial research provider, is the featured stock from July’s Most Dangerous Stocks Model Portfolio. IQV was also a featured Danger Zone pick in May 2018.

In 2016, IQV acquired IMS Health, which provides data and technology to the healthcare industry, and changed its name to IQVIA. The company, which had just $1.9 billion in invested capital prior to the acquisition, paid over $17.5 billion when factoring in the debt it took on as part of the deal.

The acquisition led to a nearly 1000% increase in invested capital. Put simply, IQVIA paid $17.5 billion for $192 million in annual NOPAT, an ROIC of just 1%. Per Figure 2, IQVIA’s economic earnings – the real cash flows of the business, which account for the cost of capital – have been negative since the acquisition.

Figure 2: IQVIA’s Misleading Earnings

Sources: New Constructs, LLC and company filings

At IQV’s current price of $102/share, the market’s expectations for profit growth look overly optimistic. To justify its current price, IQV must immediately raise its NOPAT margin to 11% (compared to 7% TTM) and grow NOPAT by 14% compounded annually for the next seven years. See the math behind this dynamic DCF scenario.

Even if company can achieve a 9% NOPAT margin (regaining the pre-tax margins of 12% it earned in 2015-2016 and benefiting from a reduction of its tax rate to 24%) and grow NOPAT by 8% compounded annually over the next decade, the stock is worth $62/share today – a 39% downside. See the math behind this dynamic DCF scenario here.

As investors focus more on fundamental research, research automation technology is needed to analyze all the critical financial details in financial filings. Below are specifics on the adjustments we make based on Robo-Analyst findings in IQVIA Holdings’ 2017 10-K:

Income Statement: we made $2 billion of adjustments, with a net effect of removing $655 million in non-operating income (7% of revenue). We removed $1.3 billion in non-operating income and $657 million in non-operating expenses. You can see all the adjustments made to IQV’s income statement here.

Balance Sheet: we made $2.5 billion of adjustments to calculate invested capital with a net increase of $514 million. One of the largest adjustments was $629 million due to operating leases. This adjustment represented 3% of reported net assets. You can see all the adjustments made to IQV’s balance sheet here.

Valuation: we made $13 billion of adjustments with a net effect of decreasing shareholder value by $12 billion. Apart from $11 billion in total debt, which includes the $629 million in operating leases noted above, the largest adjustment to shareholder value was $715 million in deferred tax liabilities. This adjustment represents 3% of IQV’s market cap.

This article originally published on July 10, 2018.

Disclosure: David Trainer, Kyle Guske II, and Sam McBride receive no compensation to write about any specific stock, style, or theme.

Follow us on Twitter, Facebook, LinkedIn, and StockTwits for real-time alerts on all our research.

[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] Ernst & Young’s recent white paper “Getting ROIC Right” proves the superiority of our holdings research and analytics.

DISCLOSURE: David Trainer, Kyle Guske II, and Sam McBride receive no compensation to write about any specific stock, style, or theme.


The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
TYPE Monotype Imaging Holdings Inc. 20.20 -0.25 -1.22 97,153 Trade
MKSI MKS Instruments Inc. 101.40 -0.30 -0.29 344,391 Trade
K Kellogg Company 70.20 0.60 0.86 1,330,466 Trade
0JDM:LN IQVIA Holdings Inc - Ordinary Shares 98.69 0.00 0.00 0

Comments

Emerging Growth

IMV Inc.

Immunovaccine Inc is clinical stage biopharmaceutical company. The Company develops products based on its proprietary vaccine enhancement platform in T cell activating therapies for cancer.