Over the last six months, ADT’s shares have sunk to $6.98, producing a disappointing 15.5% loss - a stark contrast to the S&P 500’s 7.9% gain. This may have investors wondering how to approach the situation.
Is there a buying opportunity in ADT, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Do We Think ADT Will Underperform?
Even with the cheaper entry price, we're swiping left on ADT for now. Here are three reasons why ADT doesn't excite us and a stock we'd rather own.
1. Long-Term Revenue Growth Flatter Than a Pancake
Reviewing a company’s long-term sales performance reveals insights into its quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Unfortunately, ADT struggled to consistently increase demand as its $5.14 billion of sales for the trailing 12 months was close to its revenue five years ago. This wasn’t a great result and signals it’s a low quality business.
2. Cash Flow Margin Set to Decline
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
Over the next year, analysts predict ADT’s cash conversion will slightly fall. Their consensus estimates imply its free cash flow margin of 19.2% for the last 12 months will decrease to 19.2%.
3. Previous Growth Initiatives Haven’t Impressed
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).
ADT historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 7.4%, somewhat low compared to the best consumer discretionary companies that consistently pump out 25%+.
Final Judgment
ADT doesn’t pass our quality test. After the recent drawdown, the stock trades at 7.6× forward P/E (or $6.98 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are superior stocks to buy right now. We’d suggest looking at a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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