HIDDEN GEMS:
1. Our discounted cash flow analysis shows that MSFT’s current valuation (stock price of $24.73) implies that the company’s profits will decline by 20% and never grow again.
2. The company has $43,292mm in Excess Cash (over 20% of the market cap), which we remove from our Invested Capital calculation and which helps drive a whopping 61.6% ROIC.
3. Our economic earnings models shows profits are growing, not declining, which makes the Risk/Reward for MSFT Very Attractive.
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CBS’s get our Very Dangerous Rating. 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: CBS reported a $11,899mm increase in GAAP earnings while our model shows economic earnings declined by $548mm.
2. Underfunded Pensions of $2,239mm (20% of market value)
3. Asset-write-offs of $10,559mm in asset write-offs (50% of Net Assets and nearly 100% of the market value)
4. High Valuation: market price implies CBS must grow its revenue at 10% compounded annually for 23 years and increase its ROIC from 2.4% to 6% over the same time frame.
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icad (ICAD) 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 10 years while also improving ROIC from -3.7% to 1.5% within the same time frame.
2. Option Liabilities: of $2.1mm or 3% of the current market value
3. Asset-write-offs: $4.4mm or 7% of Net Assets
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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.
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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.
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Dangerous Rating with several RED FLAGS. See my recent post Mayo Is Right about Citi for details on our analysis of the company’s loose Deferred Tax accounting and other Red Flags. There are other reasons to run from this stock.
RED FLAGS:
Over $7bn in off-balance sheet debt
$2.2bn in under-funded Pension liabilities
Over $10bn in Asset write-offs
Very Dangerous valuation (detail follow)
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The end of the Speculative Movement and the momentum-investing fad means we are entering an environment more conducive to value investing or, more specifically, an environment where skill in assessing the true economic profitability and valuation of companies will determine the success of stock-pickers.
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I believe that most of the traders and speculators who have been successful enough to stay afloat will be forced to exit the business or shift to a value investment style – an endeavor in which I expect very, very few to be successful. And though there will be fewer speculators, enough will remain to keep the markets from being too efficient.
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David is a Wall Street veteran and corporate finance expert.