– By GF Value
The stock of Watsco (NYSE:WSO, 30-year Financials) is believed to be significantly overvalued, according to GuruFocus Value calculation. GuruFocus Value is GuruFocus’ estimate of the fair value at which the stock should be traded. It is calculated based on the historical multiples that the stock has traded at, the past business growth and analyst estimates of future business performance. If the price of a stock is significantly above the GF Value Line, it is overvalued and its future return is likely to be poor. On the other hand, if it is significantly below the GF Value Line, its future return will likely be higher. At its current price of $283.68 per share and the market cap of $10.9 billion, Watsco stock gives every indication of being significantly overvalued. GF Value for Watsco is shown in the chart below.
Because Watsco is significantly overvalued, the long-term return of its stock is likely to be much lower than its future business growth, which averaged 2.9% over the past three years and is estimated to grow 5.14% annually over the next three to five years.
It is always important to check the financial strength of a company before buying its stock. Investing in companies with poor financial strength have a higher risk of permanent loss. Looking at the cash-to-debt ratio and interest coverage is a great way to understand the financial strength of a company. Watsco has a cash-to-debt ratio of 1.01, which is in the middle range of the companies in Industrial Distribution industry. The overall financial strength of Watsco is 8 out of 10, which indicates that the financial strength of Watsco is strong. This is the debt and cash of Watsco over the past years:
Investing in profitable companies carries less risk, especially in companies that have demonstrated consistent profitability over the long term. Typically, a company with high profit margins offers better performance potential than a company with low profit margins. Watsco has been profitable 10 years over the past 10 years. During the past 12 months, the company had revenues of $5.1 billion and earnings of $6.781 a share. Its operating margin of 7.71% better than 76% of the companies in Industrial Distribution industry. Overall, GuruFocus ranks Watsco’s profitability as fair. This is the revenue and net income of Watsco over the past years:
Growth is probably the most important factor in the valuation of a company. GuruFocus research has found that growth is closely correlated with the long term performance of a company’s stock. The faster a company is growing, the more likely it is to be creating value for shareholders, especially if the growth is profitable. The 3-year average annual revenue growth rate of Watsco is 2.9%, which ranks in the middle range of the companies in Industrial Distribution industry. The 3-year average EBITDA growth rate is 2%, which ranks in the middle range of the companies in Industrial Distribution industry.
Another way to look at the profitability of a company is to compare its return on invested capital and the weighted cost of capital. Return on invested capital (ROIC) measures how well a company generates cash flow relative to the capital it has invested in its business. The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. We want to have the return on invested capital higher than the weighted cost of capital. For the past 12 months, Watsco’s return on invested capital is 15.60, and its cost of capital is 5.97. The historical ROIC vs WACC comparison of Watsco is shown below:
In summary, The stock of Watsco (NYSE:WSO, 30-year Financials) is estimated to be significantly overvalued. The company’s financial condition is strong and its profitability is fair. Its growth ranks in the middle range of the companies in Industrial Distribution industry. To learn more about Watsco stock, you can check out its 30-year Financials here.
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This article first appeared on GuruFocus.