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For beginners, it can seem like a good idea (and an exciting prospect) to buy a company that tells a good story to investors, even if it completely lacks a track record of revenue and profit. But as Warren Buffett has mused, 'If you've been playing poker for half an hour and you still don't know who the patsy is, you're the patsy.' When they buy such story stocks, investors are all too often the patsy.
In the age of tech-stock blue-sky investing, my choice may seem old fashioned; I still prefer profitable companies like Energy Recovery (NASDAQ:ERII). Now, I'm not saying that the stock is necessarily undervalued today; but I can't shake an appreciation for the profitability of the business itself. 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.
How Fast Is Energy Recovery Growing Its Earnings Per Share?
Over the last three years, Energy Recovery has grown earnings per share (EPS) like young bamboo after rain; fast, and from a low base. So I don't think the percent growth rate is particularly meaningful. As a result, I'll zoom in on growth over the last year, instead. Like a falcon taking flight, Energy Recovery's EPS soared from US$0.32 to US$0.47, over the last year. That's a commendable gain of 48%.
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). The good news is that Energy Recovery is growing revenues, and EBIT margins improved by 5 percentage points to 17%, over the last year. Ticking those two boxes is a good sign of growth, in my book.
The chart below shows how the company's bottom and top lines have progressed over time. To see the actual numbers, click on the chart.
Fortunately, we've got access to analyst forecasts of Energy Recovery's future profits. You can do your own forecasts without looking, or you can take a peek at what the professionals are predicting.
Are Energy Recovery Insiders Aligned With All Shareholders?
It makes me feel more secure owning shares in a company if insiders also own shares, thusly more closely aligning our interests. So it is good to see that Energy Recovery insiders have a significant amount of capital invested in the stock. Indeed, they hold US$26m worth of its stock. That's a lot of money, and no small incentive to work hard. Despite being just 4.5% of the company, the value of that investment is enough to show insiders have plenty riding on the venture.
It's good to see that insiders are invested in the company, but are remuneration levels reasonable? A brief analysis of the CEO compensation suggests they are. For companies with market capitalizations between US$200m and US$800m, like Energy Recovery, the median CEO pay is around US$1.7m.
The Energy Recovery CEO received US$1.1m in compensation for the year ending December 2018. That comes in below the average for similar sized companies, and seems pretty reasonable to me. CEO remuneration levels are not the most important metric for investors, but when the pay is modest, that does support enhanced alignment between the CEO and the ordinary shareholders. It can also be a sign of a culture of integrity, in a broader sense.
Does Energy Recovery Deserve A Spot On Your Watchlist?
Given my belief that share price follows earnings per share you can easily imagine how I feel about Energy Recovery's strong EPS growth. If you need more convincing beyond that EPS growth rate, don't forget about the reasonable remuneration and the high insider ownership. This may only be a fast rundown, but the takeaway for me is that Energy Recovery is worth keeping an eye on. Now, you could try to make up your mind on Energy Recovery by focusing on just these factors, or you could also consider how its price-to-earnings ratio compares to other companies in its industry.
Although Energy Recovery 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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.