Monday, October 10, 2016

Don't Judge a Stock By It's Name

When people want to buy shares in a company this is what they normally do:

1. Listen to what's said on CNBC or Bloomberg, their friends, and the wise man at the bar.
2. Read a recent article or two on the company.
3. Look at a few charts of the stock heading higher
4. Hit the buy button at their online broker confident they will be hitting a home run.

Now here is the problem with those 4 steps.  That's not what professionals do, and they will slaughter you in the process. Professionals for one are much better at technical analysis(3. analyzing charts). Two they have loads of
information available to them which is analyzed according to their criteria.

Another thing they do is compare the company to it's competitors to make sure they are getting the best of breed, and not the best advice from the local rube. They want to see how the company operates versus it's competitors to see which is better managed. This is just another day in the life of big mutual and hedge funds.

Today I'm going to take a look 4 companies. We'll see how the metrics of each company can affect your decision on which one would be the better buy. Maybe you'll realize that what you hear on TV isn't always the best idea.

In our first example I have Company A and B.  I've listed some common metrics to see how each is handling its growth, balance sheet, and management effectiveness ratios.

Company ACompany B
Rev Change MRQ33.00%9.00%
Rev Change % TTM23.40%1.30%
Rev Growth 5 YR AVG103.00%1.90%
Gross Margin ttm21.40%19.90%
Current Ratio mrq1.381.3

Based on this first set of metrics it appears Company A is the better buy.  They are smoking it with large revenue increases compared to B which appears to be a slow grower. Their gross margin & balance sheet's current ratio are similar. So right now based on that most people would say Company A is the one you want to buy.  Let's take a look at some management performance metrics.

Company ACompany B
ROA ttm-12.30%10.30%
ROE ttm-69.60%46.30%
ROI ttm-18.50%16.50%
Net Profit Margin ttm-24.60%7.40%
Price to Book mrq11.78.1

WOW quite the stark difference!  The two companies have basically become mirror opposites with this set of metrics.  Company B is clearly the much better managed company. Additionally Company A is losing money as evidenced by it's negative -24.60% Net Profit Margin. Meanwhile Company B is making a respectable 7.40% profit at the end of the year. 

Next you might be thinking how have the shares performed*. In the last 3 years Company A is up 25%, while Company B is up slightly more at 27%. Makes it perplexing doesn't it? Especially since both companies are in the automotive industry, and both are considered players in the new autonomous driving field. You could either make the case that either Company has run up to far, or maybe Company B is undervalued. We'll let the market decide this one :) 

So who are these companies? 

Company A is Tesla(TSLA), and Company B is Delphi Automotive(DLPH).  I bet most people are wondering who Delphi is, but they have been making car parts for decades. They even describe themselves as a high-tech company. That's fitting as they develop and manufacture many of the systems incorporated into autonomous vehicles. I bet most people never would have thought about investing in this company. All you hear about in the news is how Tesla has the groundbreaking technology. But they can't make a profit. All the while Delphi is in the same field with it's own high-tech gadgetry, and makes money each year. I'll add they pay a decent dividend too.

Let's take a look at two more companies

Company CCompany D
Rev Change MRQ37.2%-3.6%
Rev Change % TTM47.2%-3.4%
Rev Growth 5 YR AVGN/A1.1%
Gross Margin ttm33.9%39.8%
Current Ratio mrq3.441.89

First I want to point out that Company C has not been a public company long enough to have five years of revenue growth. Either way we see that compared to Company D its showing rapid growth instead of declining sales. Even the balance sheets current ratio for Company C is better based on that metric, and margins are pretty similar. As of right now I bet most people would want to buy the shares of this new hot stock

Now as you expected here are the second set of metrics. 

Company CCompany D
ROA ttm6.1%13.9%
ROE ttm13.4%89.1%
ROI ttm7.1%15.1%
Net Profit Margin ttm8.5%18.8%
Price to Book mrq10.2155

Crazy that just like the first example these two companies have stark differences between the two data sets. Company D has some outliers with ROE and Price to Book coming in rather high. While outside the realm of our discussion in this post, these are items you should look into further when evaluating a company. For the most part Company D is doubling it's management effectiveness performance vs Company C with nice ROA and ROI.  I might add that Company D's 18.8% profit margin is quite impressive, and Company C still does a good job. Anytime I see a Net Profit Margin over 15% that smells like a well run company to me.

How about share performance? Since Company C has only been around since Jan 2015 I ran share performance since then.  For Company C shares are actually down 19% since the IPO. Company D shares on the other hand are up 28%, and that's with lagging sales. A fun fact for Company C is at one point each location was valued at nearly $30 million, but is now down to a slightly less ludicrous $13 million.

So which two companies are we comparing?

Company C is none other than the blazing hot Shake Shak(SHAK). Company D I bet many are now guessing is McDonald's(MCD). If we were to judge by share performance alone I bet many people would think it should be the other way around for which company should be up more. But the market values companies differently on a number of factors. The shares respond accordingly. I'm sure most people would be confounded to hear that unhealthy, bad for you, blah blah blah McDonald's stock is up that much. Shareholders seem to be having a nice time.

The takeaway from today's article is you shouldn't judge a stock by what you hear on TV, or what you think is going to be a great investment. Benjamin Graham said it best.

You can get in way more trouble with a good idea than a bad idea,because you forget that the good idea has limits.” 

You will get in trouble if you invest on "good ideas" alone. Take a look at the numbers. What do they tell you? Researching a companies operating performance, and recent share performance are essential in order to minimize your risk, and maximize your upside. Based on the numbers I showed you today it's all too apparent. 

*Share price performance is from mid-Sept when I began writing the article, and presented this info originally on Topstep Traders Squawk Radio 9/21/16. 

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