Do You Own The Worst Stock In The Market?

Great companies can be bad stocks.

Now, that sounds like a neat, pithy phrase to throw around (feel free to borrow it!), but it can be a lot more nuanced than you might expect. For example, if the current valuation fully reflects a company’s prospects, then there’s little opportunity to outperform even if the company is “great.” In addition, stocks move up and down 20% or more on a regular basis. Just because a stock is declining doesn’t mean the company is “bad.”

Parsing the difference between “good” and “bad” is my wheelhouse. Let me show you.

I recently updated my earnings-quality software, and I saw that one of the worst stocks in the market is regarded as a “great” company. The company is in a stodgy and stable business, has a brand name, and been in business over 100 years.

But, the numbers have deteriorated in recent quarters and the overall earnings quality score suggests that stock is one of the worst to own in the S&P 500.

Let’s take a look at the metrics that my software spat out:

Revenue Quality: F

Based on the cash-flow statement of the annual report, receivables continued to rise excluding the effect of acquisitions. Lengthening collection terms when a company is facing material slowdowns in revenue growth increases the risk that the company pulled forward future revenue into the current quarter.

Cash Flow Quality: F

Due to acquisition accounting, companies obtain a benefit to operating cash flows while the cost of the acquisition is treated as an investing cash flow. Despite this benefit, the company’s cash flow quality has deteriorated. Free cash flow has plummeted to negative levels while operating cash flow on a trailing 12-month basis is exhibiting the worst trends in years.

Earnings Quality: F

The company consistently generates negative “Cash EPS” quarter after quarter. This is my proprietary metric that measures the degree a company uses the balance sheet to influence quarterly earnings. The company scores very poor marks here. In addition, the spread between EBITDA Margins to Operating Cash Flow Margins as started to widen considerably post acquisition activity. This is a sign that profits are not translating into sustainable cash flows.