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Company had warning signs before '60 Minutes'

Tuesday, April 14th, 2015

I'm always looking for companies that have a lot of value but have had a problem that has brought the stock to normal levels from levels that were not sustainable.

As an investor, when you are overpaying for a company and you think the momentum will just keep taking that stock higher, the last thing you want to hear is that on Sunday night your company is on “60 Minutes.”

This is exactly what happened with Lumber Liquidators Holdings Inc. (NYSE: LL).

It wasn't too long ago that the stock was trading well over 20 forward times for earnings and the company could do no wrong.

Then “60 Minutes” reported that some of the company’s flooring made in China may have unsafe levels of formaldehyde, a known carcinogen, and the stock began to fall from nearly $100 to $50 per share, and then was cut nearly in half to $28 per share.

The stock has since recovered to the low 30s, so I thought now might be a good time to look at investing into Lumber Liquidators.

The trailing 12-month price-to-earnings ratio now looks reasonable at 14.4, well below the industry average of 24.4. Price to sales is also exciting, looking at 0.86 — not quite half the industry average of 1.58.

Price to book value is also very attractive at 2.79, far below the industry average of 12.1. And of the valuation ratios that I look at is price to cash flow, which stands at 11.5 for the company versus the industry at 16.78.

The company does not pay a dividend, which is not important to me if the company is growing its sales and earnings and can use that money to continue to grow the business.

Year over year for the past 12 months, the company grew sales at 4.7 percent, slightly less than the industry of 5.42 percent.

Earnings per share over the same timeframe declined by 16.7 percent, while the industry shows earnings growth of 25.2 percent. These numbers are for the period ending Dec. 31, 2014.

Anyone who bought the stock after these numbers were released did not take the time to look at them, didn't care or didn’t understand that sales and earnings were not doing well.

The balance sheet should give investors some comfort but a closer look would reveal not to get too comfortable.

The current ratio for the company looks very good at 2.48 versus the industry at 1.24. But while that may sound good to some investors, a closer look reveals that the quick ratio is only 0.30, which tells me the nice-looking current ratio is mostly accounts receivable and inventory — not the best liquid assets.

The return on equity looks good at 19.8, which is above my comfort zone of 15, but the industry does have a return on equity of 41.3. The net profit margin is 6.1, which is below the industry at 6.5.

Here again, I am baffled why someone would pay a high premium for this company when the sales, earnings and net profit margin are not as good as the industry average.

If I had looked at this company when the earnings came out, I would have noticed that the inventory turnover of the past 12 months is 2.2, nearly half the industry average of 4.2. This can be a flashing red light that the company is having difficulty.

Looking at GAAP earnings estimates going forward, the mean calculation of 12 analysts looking for December 2016 earnings is $2.31. The range of these 12 analysts, from low to high, is 100 percent, with the high estimate being $3.04 and low at $1.52. This, too, is a concern when the range of the estimates is so extreme, displaying potential problems with this company.

Using a forward multiple PE of 16.5 would tell investors that a reasonable selling price for this stock would be $38.12. With the stock currently about $33 a share, that is only a potential growth of 15 percent.

When I invest in a company, I like to have a potential gain from the stock price to the target price of at least 30 percent. After doing more research on this company and understanding the problem with its flooring, and deciding whether it is a fixable problem and that the company would not be facing major legal issues, I would consider buying the stock at $29 per share, assuming that the forward earnings remain at $2.31.

I have not done that research yet, so if you are going to invest in this company, make sure you understand its problem completely before investing your money.

Do you have a question or a company you would like us to take a look at?
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