Drugstore.com (DSCM) 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 15 years while also improving ROIC from –2.3% to 10.9% within the same time frame.
2. Off Balance-Sheet debt: of $15mm or 15% of Net Assets
3. Asset-write-offs: $210mm or 206% of Net Assets
The reason we focus on Economic Earnings as opposed to Accounting Earnings is because Accounting Earnings are subject to too much manipulation – as Charlie Munger states below. This problem is not going away anytime soon.
The Munger version of that is “easy money corrupts, and really easy money tends to corrupt absolutely.”
We have always known that finding data is the Footnotes is, for most investors who are without our patented Research Platform, like searching for needles in a haystack. With XBRL, the only difference is now investors can search for digital needles in a digital haystack. Funny how little things change.
As follow-on to my 3-part Market Outlook series of posts, I am highlighting a quote from GaveKal research’s Daily note today which supports my assertion that the “Easy Money Days Are Over” and that success in stock-picking will rely on superior analytical skills as opposed to the market-timing skills that have predominated most of the past 25 years (see Market Outlook Part 1: Rise of the Speculative Movement).
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.