With the talking heads spinning narrative’s day in and day out, investors can feel more confused than ever. As the S&P 500 falls from record highs, investors may be wondering how to navigate this market?
There is one straight answer: make sure you’ve done your diligence and understand the true cash flows of the underlying business you’re looking to invest in (or already own).
The sole purpose of my Most Dangerous Stocks Model Portfolio is to find the worst of the worst stocks in any kind of market. The stocks in this Model Portfolio have both terrible fundamentals and expensive valuations. In other words, the risk/reward for these stocks is very dangerous.
To help my readers protect their portfolios, here’s a stock pick from this Model Portfolio.
This feature provides a concise summary of how I pick stocks for this Model Portfolio. It is not a full Danger Zone report, but it gives you insight into the rigor of my firm’s research and approach to picking stocks.
Free Most Dangerous Stock Pick: Dayforce Inc. (DAY)
Dayforce Inc. (DAY) is the featured stock from February’s Most Dangerous Stocks Model Portfolio.
Dayforce’s net operating profit after tax (NOPAT) margin fell from 9% in 2018 to 5% in the TTM, while the company’s invested capital turns rose from 0.3 to 0.4 over the same time. Falling NOPAT margins offset the improved capital turns and drive Dayforce’s return on invested capital (ROIC) from an already low 2.4% in 2018 to 1.9% in the TTM.
Dayforce’s economic earnings, a key component of the Golden Metric for picking stocks, fell from -$197 million in 2018 to -$389 million in the TTM. Meanwhile, the company’s GAAP net income rose from -$71 million to $53 million over the same time. Whenever GAAP earnings rise while economic earnings decline, investors should beware.
Figure 1: Dayforce’ Economic vs GAAP Earnings Since 2018
DAY Provides Poor Risk/Reward
Despite its poor and declining fundamentals, Dayforce’s stock is priced for significant profit growth, and I believe the stock is overvalued.
To justify its current price of $68/share, Dayforce must improve its NOPAT margin to 15% (above best-ever NOPAT margin of 10%) and grow revenue by 25% (compared to 15% over the five years) compounded annually over the next eight years. In this scenario, Dayforce grows its NOPAT 35% compounded annually to $2.1 billion in 2033. I think these expectations are overly optimistic, especially considering the company’s NOPAT grew just 4% compounded annually over the last five years.
Even if Dayforce improves its NOPAT margin to 10% (equal to best-ever NOPAT margin) and grows revenue 20% compounded annually through 2033, the stock would be worth no more than $28/share today – a 59% downside to the current stock price.
Each of these scenarios also assumes Dayforce can grow revenue, NOPAT, and FCF without increasing working capital or fixed assets. This assumption is unlikely but allows me to create best case scenarios that demonstrate the high expectations embedded in the current valuation.
Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology
Below are specifics on the adjustments I made based on Robo-Analyst findings in Dayforce’s 10-Qs and 10-Ks:
Income Statement: I made around $50 million in adjustments, with a net effect of removing just under $50 million in non-operating expenses.
Balance Sheet: I made over $1.1 billion in adjustments to calculate invested capital with a net decrease of just under $200 million. One of the most notable adjustments was for other comprehensive income.
Valuation: I made just under $1.8 billion in adjustments to shareholder value with a net decrease of just under $1.0 billion. The most notable adjustment to shareholder value was for total debt.
Disclosure: David Trainer, Kyle Guske II, and Hakan Salt receive no compensation to write about any specific stock, style, or theme.