Value Traps

  • 19 Oct
    Want to get defensive? Stay away from this value trap

    Want to get defensive? Stay away from this value trap

    The market’s volatility over the last week and a half has started to put a lot of people on edge. I’ve noticed an increasing number of talking heads on market media starting to throw out words that just don’t apply to the market yet, like “correction” and even “bear market” in a few cases. It’s pretty easy to get caught up in the hand-wringing and anxious nerves that always seem come when market volatility starts to pick up. More →

  • 11 Oct
    SIG: value stock, or value trap?

    SIG: value stock, or value trap?

    Sometimes, answering the question of whether a stock represents a legitimate, attractive value opportunity can be hard to do. A company could be struggling not only to grow its business, but may be forced to restructure its business in a way that makes most of the traditional measurables investors like to use look very unfavorable. More →

  • 03 Oct
    GE just hired a rock star CEO. Is it time to call them a good value play?

    GE just hired a rock star CEO. Is it time to call them a good value play?

    The market was buzzing at the beginning of the week when General Electric Company’s (GE) board announced they were firing the CEO they brought in just a little over a year ago, John Flannery, and replacing him with Larry Culp, the 54-year old former CEO of Danaher Corporation (DHR). The news pushed the stock up overnight in a big way, as it opened Monday morning nearly 16% above its closing price on Friday. More →

  • 28 Sep
    Which auto stock is a better investment right now: FCAU, GM or F?

    Which auto stock is a better investment right now: FCAU, GM or F?

    Earlier this week, I wrote about recent opinions I’ve seen that suggest that the stock market’s long, extended bullish run still has plenty of life left to keep going. One of the most compelling arguments supporting that opinion is the fact that, after the market’s big correction in the early part of this year, most of the market’s recovery has been led by beaten-down stocks in previously under-appreciated and oversold industries. That suggests the bullish momentum that has pushed the market higher since April when it found a corrective bottom is driven by an emphasis on value, which does offer some very compelling food for thought. Value-driven market rotation usually happens at the beginning of a bull market, not in the latter stages of one, so I think there could more than a little truth behind the notion.

    Let’s go ahead assume for the time being that this idea is correct; it begs the next question, which is naturally, where am I going to find the best values in the market right now? It’s one thing to tell you to look for beaten-down stocks in depressed industries; it’s quite another to actually recognize what some of those areas of the market are right now.



    As I previously mentioned, the auto industry is an area of the market that has really come under a lot of pressure. While the broad market has seen a nice rally since April of this year, the Big Three automakers have all seen significant drops in price. Fiat Chrysler Automotive (FCAU), Ford Motor Company (F) and General Motors Company (GM) are all down around 25% since reversing lower from their respective high points in April and June. Yes, a not-insignificant part of that drop has been driven by trade-related tensions with all four of America’s largest trading partners, and for as long as those tensions persist, there remains an element of risk that could keep pushing these stocks lower. Even so, the fact they are all down in bear market territory should at least have any sensible value-oriented investor sit up, take notice, and consider whether there is an opportunity worth thinking about.

    What follows is a comparison of all of the Big Three U.S. automakers, side by side, to determine which of the three actually poses the best value-based argument right now. Does that mean that you should think about taking a position in the winner right now? That is for you to decide.



    Earnings/Sales Growth

    • Ford: Over the last twelve months, earnings decreased by almost 52% while sales were mostly flat, declining by only about 2%. The company operates with a narrow margin profile that saw Net Income at 4.2% of Revenues over the last twelve months, and decreased to only about 2.7% in the last quarter.
    • GM: The twelve-month pattern for GM shows earnings decreasing only a little over 4%, and sales mostly flat, declining about .6%. GM’s margin profile over the last twelve months showed Net Income was a negative 3.2%, but improved in the last quarter to positive 6.5%.
    • Fiat Chrysler: Earnings over the last twelve months declined 2.63% for FCAU versus sales growth of 12.62%. The company’s margin profile showed Net Income as 3.1% of Revenues in the last twelve months, and declining to 2.5% for the most recent quarter.

    Winner: FCAU, on the basis of superior earnings and sales results in the last year versus F or GM.

    Free Cash Flow

    • Ford: F’s free cash flow is quite healthy, at more than $9.1 billion over the last twelve months. That translates to a Free Cash Flow Yield of 23.5%, which is extremely attractive.
    • GM: GM has operated with negative Free Cash Flow since the last quarter of 2016, and as of the last quarter this number was a little more than -$12.3 billion dollars.
    • Fiat Chrysler: FCAU’s Free Cash Flow over the last twelve months is healthy at a little more than $4.9 billion. That translates to a Free Cash Flow Yield of 13.8%

    Winner: F, with the highest total dollar amount in Free Cash Flow over the twelve months along with the most attractive Free Cash Flow Yield.



    Debt to Equity

    • Ford: F has a debt/equity ratio of 2.8. High debt/equity ratios aren’t unusual for automotive stocks, however it should be noted that F’s debt/equity is the highest among the Big Three auto companies. The company’s balance sheet demonstrates their operating profits are sufficient to service their debt, with healthy liquidity to make up any potential difference if that changes.
    • GM: GM’s debt/equity ratio is 1.81, which is also pretty high, but below that for F. The difference, however is that while GM’s operating profits should be adequate to service their debt, they may not have enough liquidity to make up any potential operating shortfall.
    • Fiat Chrysler: FCAU’s debt/equity ratio is the lowest of the group, at .46. That alone puts them well ahead of the other two in this category; but it is also worth noting that the company’s cash and liquid assets are more than 34% higher than their long-term debt. That gives them the best actual financial base to operate from out of any of the Big Three.

    Winner: FCAU. Not even close.

    Dividend

    • Ford: F pays an annual dividend of $.60 per share, which translates to a very impressive yield of more than 6% per year.
    • GM: GM’s dividend is $1.52 per year, translating to an annual yield of 4.51%
    • Fiat Chrysler: FCAU does not pay a dividend.

    Winner: F. Dividends are the low-hanging fruit that every value-oriented investor should look out for.



    Value Analysis

    • Ford: F’s Price/Book value is $9.18 per share and translates to a Price/Book ratio of 1.07 at the stock’s current price. Their historical average Price/Book ratio is 2.12, which suggests the stock is trading right now at a discount of more than 97%. The stock is also trading about 60% below its historical Price/Cash Flow ratio.
    • GM: GM’s Price/Book value is $27.38 and translates to a Price/Book ratio of 1.23 at the stock’s current price. Their historical average Price/Book ratio is 1.9, which suggests the stock is trading right now at a discount of 54%. The stock is also trading more than 129% below its historical Price/Cash Flow ratio.
    • Fiat Chrysler: FCAU’s Price/Book value is $13.87 and translates to a Price/Book ratio of 1.29 at the stock’s current price. Their historical Price/Book ratio is 1.32, suggesting the stock is trading at a discount of 2.3%. The stock is also trading 55% above its historical average Price/Cash Flow ratio, suggesting the stock remains significantly overvalued, even at its current price.

    Winner: F, edging out GM for best overall value proposition, but not by a wide margin.

    The net winner? While FCAU has the best overall fundamental profile, it offers the least upside potential, with a significant level of downside risk. That puts F squarely in the winner’s circle for the best overall opportunity among the Big Three automakers under current market conditions. On the other hand, the greatest overall risk remains with GM, who despite the upside offered by its value measurements, has some big fundamental question marks that make the value proposition hard to justify.


  • 26 Sep
    GPRE: Sometimes a cheap stock is just a cheap stock

    GPRE: Sometimes a cheap stock is just a cheap stock

    If you spend a lot of time paying attention to the stock market, you start to build a pretty long list of stocks that you follow. A lot of the stocks you pay the most attention to are the ones that have been the most productive for you in terms of functional trading; they’re the ones that you’ve been able to turn back to on multiple different occasions, with generally positive results. More →

  • 19 Sep
    Retail stocks are up – but there’s a good reason why DDS isn’t following suit

    Retail stocks are up – but there’s a good reason why DDS isn’t following suit

    Perhaps it’s an indication of over-exuberance that the market has lately seemed to just shrug off the latest global trade news. It could also be that investors have come to accept tariff threats and trade tensions as “the new normal.” Either way, it is interesting that while the Trump administration imposed a new set of tariffs on China, the market today decided to use the fact that the tariffs were set at a lower-than-expected 10% instead of the 25% that many had feared as a catalyst to drive higher. More →

  • 11 Sep
    Why you shouldn’t fall for the value trap that is TEX

    Why you shouldn’t fall for the value trap that is TEX

    A couple of weeks ago, I wrote about Oshkosh Corporation (OSK), a mid-cap stock in the Heavy Machinery industry that is trading at a steep discount right now, and that I think looks like a pretty interesting value-based opportunity. The entire industry is pretty depressed right now, and you don’t have to look much further than the biggest names in the industry More →

  • 03 Sep
    Which stock is a better actual value: GIL or HBI?

    Which stock is a better actual value: GIL or HBI?

    When you spend a lot of time analyzing different segments of the market, it isn’t all that unusual to come across two competing companies in an industry that both look appear to have a pretty good argument as a good bargain opportunity in the making. When it happens, as an investor you have a decision: which one should you pick? Or, if you have the capital to work with, should you bother choosing at all, or simply work with both of them? It’s the kind of thing that I like to call “a good problem to have,” because you get to choose between two pretty good things, and that usually means that whatever you decide to do, you’ll have a pretty good chance of seeing it work out okay.

    The problem, of course, is that just because you might find a couple of stocks in the same industry that look good, it doesn’t mean that everything is as it seems. Sometimes what looks like a great opportunity is, in reality a bigger risk than you might realize until it’s too late. This is the situation I found myself in earlier this week when I started evaluating Gildan Activewear Inc. (GIL) and HanesBrands Inc. (HBI), two stocks in the Textiles & Apparel industry. You’ve probably heard of HBI, of course; I don’t think there are too many men who haven’t worn a Hanes or Champion t-shirt, or that many women who haven’t bought Maidenform or Wonderbra undergarments or L’eggs nylon stockings. You may not be as familiar with GIL; they make the same products as HBI, and they sell them under some of their own brands, like Gold Toe, American Apparel, and others. A big portion of their business, however, focuses on branded apparel for the printwear market.



    I’ve followed both stocks for some time, in part because I like both of their products; for another, I think that while the industry exists in the Consumer Discretionary sector, which can be subject to economic cyclicality, the specific niche they both reside in makes them pretty attractive as stocks that should hold up well when the economy shifts to the downside. I like the idea of working with stocks like these as defensive positions; and the fact is that both stocks have generally underperformed the market over the course of the year.

    This week the S&P 500 pushed above resistance from its late January high after the Trump administration it had reached an agreement with Mexico to rework the NAFTA trade agreement; the market seems anxious to treat the news as the first domino to fall in favor of easing trade tensions with America’s largest and most important trading partners. There’s a long way to go, however, and a completion of the agreement, or of seeing it affect the other countries the Trump administration has targeted with tariffs in the way many hope it could isn’t a given. Even if things work out as many hope in the long run, the fact remains that the market is so extended that a significant reversal is inevitable sooner or later. That means that it’s smart to keep paying attention to defensive-oriented stocks that can position you to weather the storm of a reversal more effectively than stocks trading at extremely high valuations are.

    The fact that both stocks are well below their 52-week highs is a positive, of course, but it still doesn’t mean that they both automatically represent a terrific value right now. The truth is that if you simply paid attention to each stock’s current long-term downward trend, you’d probably conclude HBI is the better option, since it is only about $1 above its 52-week low price right now, down nearly 25% so far in 2018 and almost 32% lower for the past twelve months. By comparison, GIL is down only about 14% so far for the year, and only about 6% for the last twelve months. Digging deeper into the fundamentals for each stock, however paints a pretty different picture.



    Gildan Activewear, Inc. (GIL)

    Current Price; 29.45

    • Earnings and Sales Growth: Over the last twelve months, earnings grew by a little over 6%, while revenue increased almost 7%.  The numbers for GIL have gotten better recently, however, with earnings growing nearly 53%, and revenue improving more than 18% in the last quarter. The company cited strength in its United States-focused brands in its last earnings report, which is interesting given the fact this is a Canadian stock that most would likely figure to be hurt by ongoing trade tensions with its neighbor to the south.
    • Free Cash Flow: GIL’s free cash flow is healthy, at more than $388.24 million. This is a positive, although this number has declined since the beginning of the year from a peak a little above $500 million.
    • Dividend: GIL’s annual divided is $.44 per share, which translates to a yield of 1.49% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for GIL is $9.15 and translates to a Price/Book ratio of 3.27 at the stock’s current price. The stock’s historical average Price/Book ratio is 3.32, suggesting at first blush that the stock is fairly valued. The picture gets more interesting, however, when you factor in the stock’s Price/Cash Flow ratio, which is currently running more than 70% below its historical average. That puts the stock’s long-term target price above $51 – well above its all-time high price from January of this year at around $34.50 per share.



    Hanesbrands Inc. (HBI)

    Current Price: $17.54

    • Earnings and Sales Growth: Over the last twelve months, earnings declined by more than 15%, while revenue increased about 4%.  The numbers for HBI are better in the last quarter, with earnings growing 73%, and revenue improving about 16.5% in the last quarter.
    • Free Cash Flow: HBI’s free cash flow is healthy, at more than $462 million. This is a positive, although this number has declined since the first quarter of 2017 from a peak at close to $900 million.
    • Dividend: HBI’s annual divided is $.60 per share, which translates to a yield of 3.43% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for HBI is only $2.13 and translates to a Price/Book ratio of 8.22 at the stock’s current price. The stock’s historical average Price/Book ratio is 7.18, suggesting at first blush that the stock is slightly overvalued. Like GIL, the picture gets more interesting when you consider the stock’s Price/Cash Flow ratio, which is currently running more than 200% below its historical average. That puts the stock’s long-term target price above $38, which is above the stock’s highest point since early 2015.

    Based on the numbers shown so far, both stocks look like pretty great value plays, right? Not so fast, because the truth is that I think HBI carries a much higher risk than GIL does right now, despite its much lower current price and attractive upside forecast. A significant divergence between these two companies comes when you dive into their use of debt and their operating margin profile.



    GIL currently shows $900 in long-term debt on their books. In and of itself, of course, debt isn’t automatically a bad thing, and GIL’s debt to equity ratio of .47 generally suggests the debt they have is very manageable. More importantly, the percentage of Net Income to Revenue has improved from 12.5% for the last twelve months, which is pretty healthy, to more than 14% in the last quarter. By comparison, HBI has more than $4.1 billion in long-term debt to go along with a debt to equity ratio of 5.41. That is a very high number that indicates HBI is one of the most highly leveraged companies in its industry. Their operating profile also suggests that they could have problems servicing their debt; over the last twelve months, Net Income as a percentage of Revenues was barely .5%. This number did improve in the last quarter to a little over 8%, but remains significantly below the level maintained by GIL.

    When most of the information about two stocks looks similarly attractive, a discriminating investor has to be able to split hairs to determine if one company’s opportunity is more worth the risk than the other. In this case, the fact that GIL shows a much more manageable debt burden, with operating discipline that has enabled it to not only maintain a stable level of profitability, but also to improve it, makes it a better bet than its more recognizable competitor.


  • 30 Aug
    SYMC looks like a value trap!

    SYMC looks like a value trap!

    The market looks like it’s trying to reclaim the long, extended upward run it’s been following since late 2009. This week, following the announcement of a new trade deal between the United States and Mexico, the market finally broke above the all-time high it set in January of this year before dropping back a little over 10%. More →

  • 21 Aug
    MCHP’s debt just quadrupled. The why means this stock is a scary risk

    MCHP’s debt just quadrupled. The why means this stock is a scary risk

    The semiconductor sector has been one of the most interesting sectors of the market to pay attention for the last couple of months; after unquestionably beating the market for most of the the year, the sector has been battered since June by ongoing U.S. – China trade tensions. That’s put a lot of interested investors on edge, and for some that means that semi stocks should be kept at arm’s length. For me, seeing a sector under pressure usually makes me start paying attention to as many of the most fundamentally sound stocks in the sector that I can. It also means, however that the sector could stay under pressure; and in the case of semiconductors, that pressure could continue for some time. That means that you have to be very selective about the stocks you choose to follow, and you have to be willing to let a lot of others simply pass you by.

    The fact is there are some semiconductor stocks that I think are pretty significantly undervalued right now, and that I think present some pretty good opportunities even if tariff-related volatility continues to work against the sector. MU and AMAT are two examples I’ve written about before, and that are already at extremely depressed price levels that I think represent some really impressive value propositions and are worth paying attention to. There is another major player in the industry that has also been beaten down pretty sharply, but that I think presents a higher level of risk to investors, at least for the foreseeable future, than most of the other big names represent.



    Microchip Technology (MCHP) is a company that, until their last earnings report, which was released just a little over a week ago, had an excellent fundamental profile, and a sparkling balance sheet. So what changed? The short answer is debt, although debt by itself is not categorically a bad thing. In MCHP’s case, the company completed the acquisition of Microsemi, a provider of semiconductor and system solutions for aerospace and defense, communications, data centers and industrial markets. MCHP borrowed approximately $8.1 billion – more than four times the roughly $1.9 billion that was on their books in March – to complete the acquisition. Initially hailed as an opportunity for the company to expand its presence into aerospace and defense in particular, MCHP management revealed that Microsemi’s managers had stuffed their sales channels with excess inventory in order to inflate revenues ahead of the deal’s closing, along with a culture of “excessive extravagance and high spending” that prompted them to immediately replace all of Micorsemi’s top leadership.

    The deal certainly has damped enthusiasm for the stock; the stock plunged more than $11 per share on the day of the earnings report, or a little over 11% overnight. Since that point, the stock has dropped about 7% more; since finding a top at around $104 in early June, that puts MCHP’s total decline at nearly 21% in the last two months alone. That’s bear market territory for a stock whose management also cited concerns about tariffs on their products, and disclosed about $200 million in excess inventory at Microsemi that must be reduced. Most analysts are predicting that both elements will weigh on sales for the next couple of quarters. That is the kind of negative news that is more likely to keep the stock dropping even further, and represents a much higher level of risk than even the most die-hard of value investors should probably stay away from for the time being.

    Given some of the other elements that actually make management’s expertise and effectiveness quite clear, I actually think there is likely to be a very good opportunity down the road to work with MCHP; but it could be several months down the road, and at a much more depressed price – which of course also suggests that the stock is very likely to be an incredible value story eventually. Hopefully the information I’ll share below will give you an idea about where that level might be most likely to be found.



    Fundamental and Value Profile

    Microchip Technology Incorporated is engaged in developing, manufacturing and selling specialized semiconductor products used by its customers for a range of embedded control applications. The Company operates through two segments: semiconductor products and technology licensing. In the semiconductor products segment, the Company designs, develops, manufactures and markets microcontrollers, development tools and analog, interface, mixed signal and timing products. Its functional activities include sales, marketing, manufacturing, information technology, human resources, legal and finance. Its product portfolio comprises general purpose and specialized 8-bit, 16-bit, and 32-bit microcontrollers, a spectrum of linear, mixed-signal, power management, thermal management, radio frequency (RF), timing, safety, security, wired connectivity and wireless connectivity devices, as well as serial electrically erasable programmable read-only memories (EEPROMs) and serial flash memories. MCHP has a current market cap of about $19.4 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings have grown about 21.5%, while revenues increased about 25%. The company’s margin profile shows that Net Income as a percentage of Revenues in the last quarter was only about 2.9% for the last twelve months. This is a negative that should be considered against the context of the Microsemi deal, and consideration given to a historical comparison of what MCHP management has done under normal conditions. A year ago, Net Income as a percentage of revenues was a much healthier 12.5%. It is true that not all of the decline can be attributed solely to one extremely bad deal; I think pressure from decreased sales to Chinese customers, which is likely to continue, is also coming to bear. But it should at least leaven some of the negativity about the company’s ability to manage their earnings and sales effectively. Give them some time to work through the excess Microsemi inventory and get that organization folded into their existing structure and culture; at that point, and I believe we’ll be likely to see margins return to healthy levels.
    • Free Cash Flow: MCHP’s free cash flow is healthy, at more than $1.1 billion. This is a number that is a bit lower since the beginning of the year, but not by much – only about 6.7%. That’s pretty minimal considering the magnitude of the Microsemi problem.
    • Dividend: MCHP’s annual divided is $1.46 per share and translates to a yield of 1.76% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for MCHP is $21.75 and translates to a Price/Book ratio of 3.79 at the stock’s current price. The stock’s historical average Price/Book ratio is 4.84, which puts a target price for the stock at about $105 per share, or nearly 21% above its current price and a little above its early June highs. It’s also worth noting that Book Value increased dramatically in the last quarter from only $14 – which can be taken a direct reflection of the Microsemi acquisition (warts and all). As I already observed, I think the stock is likely to keep dropping while concerns about Microsemi and China persist. Where is the bottom? I’m not sure; but given the already pretty high discount, I think that if the stock is anywhere around $75 – or possibly lower – when the numbers start to show the company is beginning to find its way through its current predicament, the bargain proposition could be just too good to pass up. I’ll show you how I’m coming up with that price level below.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

     

    • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s longer-term upward trend, and also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock’s decline from a high at around $104 is hard to miss, of course; but the reason I’m showing you two years’ worth of price activity is to illustrate where I think the stock could begin to stabilize. It is currently sitting almost on top of the 50% retracement line; but given the stock’s current bearish momentum, and likely continued negative sentiment, I don’t expect that support to hold. The next support level, around $75, lines up with the 61.8% retracement line. Assuming the stock’s Book Value remains consistent (admittedly, not a given), a drop to $75 would put the stock at a 40% discount to its historical Price/Book Value ratio. That’s a pretty interesting price level, so if the company begins to show any signs of financial recovery from its Microsemi acquisition, it could be a screaming bargain at that point – or any price below it.
    • Near-term Keys: I really don’t see a picture for MCHP that would motivate me to want to consider any kind of bullish trade right now; any attempt to buy the stock or work with call options at its current level could only be characterized as high speculation, with prohibitively low probabilities of success. The downside risk far exceeds any upside potential right now. On the other hand, a break below the 50% retracement line at around $80 could be a good signal if you want to place a short-term, momentum-based trade to short the stock or start working with put options.


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