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Recap From January’s Picks
The Most Attractive Stocks (-3.0%) outperformed the S&P 500 (-3.3%) from January 5, 2022 through February 1, 2023 by 0.3%. The best performing large cap stock gained 11% and the best performing small cap stock was up 15%. Overall, 17 out of the 40 Most Attractive stocks outperformed the S&P 500.
The Most Dangerous Stocks (-6.3%) outperformed the S&P 500 (-3.3%) as a short portfolio from January 5, 2022 through February 1, 2022 by 3.0%. The best performing large cap short and small cap short stocks fell by 23% each. Overall, 19 out of the 35 Most Dangerous stocks outperformed the S&P 500 as shorts.
The Most Attractive/Most Dangerous Model Portfolios outperformed as an equal-weighted long/short portfolio by 1.7%.
Seven new stocks made the Most Attractive list this month, and two new stocks fell onto the Most Dangerous list. February’s Most Attractive and Most Dangerous stocks were made available to members on February 3, 2022.
The Most Attractive stocks all share a high and rising return on invested capital (ROIC) and low price to economic book value ratio. Most Dangerous stocks have misleading earnings and long growth appreciation periods implied by their market valuations.
Most Attractive Stocks Feature for February: HP Inc.
HP Inc. (HPQ) is the featured stock from February’s Most Attractive Stocks Model Portfolio.
HP has grown revenue by 6% compounded annually and net operating profit after-tax (NOPAT) by 11% compounded annually over the past five years.
The company’s NOPAT margin increased from 6% in fiscal 2016 (FYE is 10/31) to 8% in fiscal 2021, while invested capital turns rose from 1.3 to 2.2 over the same period. Rising margins and improved invested capital turns drive HP’s ROIC from 8% in fiscal 2016 to 17% in fiscal 2021.
Figure 1: Revenue & NOPAT Since Fiscal 2016
HPQ Revenue And NOPAT
New Constructs, LLC
HP Is Undervalued
At its current price of $38/share, HPQ has a price-to-economic book value (PEBV) ratio of 0.5. This ratio means the market expects HP’s NOPAT to permanently decline by 50%. This expectation seems overly pessimistic for a company that has grown NOPAT by 6% compounded annually over the past five years.
Even if HP’s NOPAT margin falls to 6% (equal to 10-year average, compared to 8% in fiscal 2021) and the company’s NOPAT falls by < 1% compounded annually for the next decade, the stock is worth $64/share today – a 68% upside. See the math behind this reverse DCF scenario. Should HP grow profits more in line with historical levels, the stock has even more upside.
Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology
Below are specifics on the adjustments I make based on Robo-Analyst findings in HP’s 10-K:
Income Statement: I made $3.4 billion in adjustments, with a net effect of removing $1.6 billion in non-operating income (2% of revenue). You can see all the adjustments made to HP’s income statement here.
Balance Sheet: I made $28.7 billion in adjustments to calculate invested capital with a net increase of $20.0 billion. One of the most notable adjustments was $22.5 billion in asset write-downs. This adjustment represented 237% of reported net assets. You can see all the adjustments made to HP’s balance sheet here.
Valuation: I made $10.5 billion of adjustments with a net effect of decreasing shareholder value by $8.3 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $1.1 billion in excess cash. This adjustment represents 3% of HP’s market cap. See all adjustments to HP’s valuation here.
Most Dangerous Stocks Feature: Azenta Inc
Azenta Inc (AZTA) is the featured stock from February’s Most Dangerous Stocks Model Portfolio.
Azenta’s economic earnings, the true cash flows of the business, fell from -$26 million in fiscal 2011 (FYE is 9/30) to -$172 million in fiscal 2021. The company’s NOPAT margin fell from 12% to -3%, while ROIC fell from 7% to -1% over the same time.
Figure 2: Economic Earnings Since Fiscal 2011
AZTA Economic Earnings
New Constructs, LLC
Azenta Provides Poor Risk/Reward
Despite its poor fundamentals, Azenta is priced for significant profit growth, and I believe the stock is overvalued.
To justify its current price of $89/share, Azenta must improve its NOPAT margin to 12% (all-time high compared to -3% in fiscal 2021) and grow revenue by 26% compounded annually for the next decade, an incredibly rare achievement. See the math behind this reverse DCF scenario. In this scenario, Azenta NOPAT rises from -$14 million in fiscal 2021 to $616 million in fiscal 2031. Given that Azenta’s cumulative NOPAT over the past decade is just $246 million, I think these expectations are overly optimistic.
Even if Azenta can achieve a NOPAT margin of 12% and grow revenue by 10% compounded annually for the next decade, the stock is worth just $30/share today – a 66% downside to the current stock price. See the math behind this reverse DCF scenario. Should Azenta’s revenue grow at a slower rate or NOPAT margins not recover to fiscal 2011 levels, the stock has even more downside.
Each of these scenarios also assumes Azenta can grow revenue, NOPAT, and FCF without increasing working capital or fixed assets. This assumption is unlikely but allows me to create truly best-case scenarios that demonstrate how high expectations embedded in the current valuation are.
Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology
Below are specifics on the adjustments I make based on Robo-Analyst findings in Azenta’s 10-K:
Income Statement: I made $195 million in adjustments, with a net effect of removing $125 million in non-operating income (24% of revenue). You can see all the adjustments made to Azenta’s income statement here.
Balance Sheet: I made $1.9 billion in adjustments to calculate invested capital with a net increase of $430 million. One of the most notable adjustments was $812 million in asset write-downs. This adjustment represented 55% of reported net assets. You can see all the adjustments made to Azenta’s balance sheet here.
Valuation: I made $642 million in adjustments, with a net decrease to shareholder value of $437 million. The most notable adjustment to shareholder value was $334 million in net assets from discontinued operations. This adjustment represents 5% of Azenta’s market cap. See all adjustments to Azenta’s valuation here.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
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