Like a puppy chasing its tail, some new investors often chase 'the next big thing', even if that means buying 'story stocks' without revenue, let alone profit. And in their study titled Who Falls Prey to the Wolf of Wall Street?' Leuz et. al. found that it is 'quite common' for investors to lose money by buying into 'pump and dump' schemes.
In the age of tech-stock blue-sky investing, my choice may seem old fashioned; I still prefer profitable companies like A. O. Smith (NYSE:AOS). While that doesn't make the shares worth buying at any price, you can't deny that successful capitalism requires profit, eventually. Loss-making companies are always racing against time to reach financial sustainability, but time is often a friend of the profitable company, especially if it is growing.
A. O. Smith's Earnings Per Share Are Growing.
As one of my mentors once told me, share price follows earnings per share (EPS). That means EPS growth is considered a real positive by most successful long-term investors. We can see that in the last three years A. O. Smith grew its EPS by 9.5% per year. That's a pretty good rate, if the company can sustain it.
I like to see top-line growth as an indication that growth is sustainable, and I look for a high earnings before interest and taxation (EBIT) margin to point to a competitive moat (though some companies with low margins also have moats). A. O. Smith's EBIT margins are flat but, of some concern, its revenue is actually down. Suffice it to say that is not a great sign of growth.
In the chart below, you can see how the company has grown earnings, and revenue, over time. For finer detail, click on the image.
Of course the knack is to find stocks that have their best days in the future, not in the past. You could base your opinion on past performance, of course, but you may also want to check this interactive graph of professional analyst EPS forecasts for A. O. Smith.
Are A. O. Smith Insiders Aligned With All Shareholders?
Since A. O. Smith has a market capitalization of US$7.7b, we wouldn't expect insiders to hold a large percentage of shares. But we are reassured by the fact they have invested in the company. Given insiders own a small fortune of shares, currently valued at US$95m, they have plenty of motivation to push the business to succeed. That's certainly enough to make me think that management will be very focussed on long term growth.
It's good to see that insiders are invested in the company, but are remuneration levels reasonable? Well, based on the CEO pay, I'd say they are indeed. For companies with market capitalizations between US$4.0b and US$12b, like A. O. Smith, the median CEO pay is around US$6.5m.
A. O. Smith offered total compensation worth US$3.5m to its CEO in the year to December 2018. That seems pretty reasonable, especially given its below the median for similar sized companies. While the level of CEO compensation isn't a huge factor in my view of the company, modest remuneration is a positive, because it suggests that the board keeps shareholder interests in mind. It can also be a sign of a culture of integrity, in a broader sense.
Is A. O. Smith Worth Keeping An Eye On?
As I already mentioned, A. O. Smith is a growing business, which is what I like to see. Earnings growth might be the main game for A. O. Smith, but the fun does not stop there. Boasting both modest CEO pay and considerable insider ownership, I'd argue this one is worthy of the watchlist, at least. Of course, identifying quality businesses is only half the battle; investors need to know whether the stock is undervalued. So you might want to consider this free discounted cashflow valuation of A. O. Smith.
Although A. O. Smith certainly looks good to me, I would like it more if insiders were buying up shares. If you like to see insider buying, too, then this free list of growing companies that insiders are buying, could be exactly what you're looking for.
Please note the insider transactions discussed in this article refer to reportable transactions in the relevant jurisdiction
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