The Roach Motel – Something Wicked

In Something Wicked This Way Comes, we provided an in-depth look at how stock repurchases are distorting McDonald’s (MCD) earnings per share and making the company look more profitable than it truly is. When such financial wizardry is considered alongside the growing popularity of passive investment strategies and overall sense of market euphoria, we have a better appreciation for why MCD trades at a valuation higher than fundamentals suggest would be appropriate.

We thought it would be helpful to extend this analysis to the entire S&P 500 to see if we can uncover other companies demonstrating fundamental and valuation divergences similar to MCD.

Who Else?

Similar to the MCD analysis, we evaluated changes in fundamentals, equity price and valuation data over the last five years for most companies that comprise the S&P 500. The data below, summarizing our broad findings, is based on 475 of the 505, S&P 500 companies. 30 companies were omitted from the analysis due to insufficient data.

141 companies, or about 30% of the S&P 500, had annualized five-year sales growth rates of 1% or less.

Of these 141 companies:

The average stock price gain over the five year period was +68%.

106 of the companies had a stock price increase of 25% or more that was concurrent with falling revenue.

The average number of shares outstanding declined by 2%. This data point is misleading as many energy companies within this group issued shares to bolster capital when the price of oil declined sharply in 2014/2015.

The average amount of debt outstanding increased 70%

The valuation ratio of market capitalization to sales increased 73%.

The table below isolates companies which had five year revenue declines of greater than 10%, price increases greater than 20%, declines in shares outstanding and increased debt outstanding.

Data Courtesy: Bloomberg

The company-specific data and the averages for this group highlight the extreme divergences that exist between poor fundamental data and current price and valuation. The list of companies showing these characteristics extend well beyond what we show here, these are just the most egregious examples.