Lubricant specialist WD-40 Company (NASDAQ: WDFC) has long capitalized on its iconic namesake brand to generate a steady and generally growing stream of earnings. It's also used that brand to expand into new product areas.
Over the years, that earnings growth has pushed the stock upward and rewarded shareholders, but so far in 2019, the stock is only up 0.5% -- far behind the S&P 500 Index's 17% advance.
Don't get too excited, there's a lot more you need to know before buying WD-40.
What a difference a quarter makes
While WD-40 is barely above where it began the year, it rallied more than 14% in July to erase its 2019 decline. The story of that share price drop is important, and almost totally driven by quarterly earnings.
Image source: Getty Images
The company's fiscal second-quarter earnings report in April disappointed Wall Street, and left investors wondering if WD-40 would be able to achieve its full-year guidance. Although management noted that the reasons why its revenues were flat were largely "normal" one-time events, the market was not mollified: The company had missed expectations, and its shares sold off, despite the fact that there was no indication from management that its business environment had materially changed.
The market's negative outlook on the stock shifted again in July when the company released fiscal third-quarter results that showed revenue and earnings trends improving. Sales increased 7% year over year, and net income rose 12%. Management again noted that fluctuations are a normal part of WD-40's business -- essentially, reminding investors that not all quarters will be good ones, but asserting that over the long term, it's on track to hit its goals.
That cautionary note seems to have fallen on deaf ears: Investors bid the stock up sharply on the earnings report. Wall Street now appears to be pricing in perfection from WD-40, which is trading near its all-time high. And that is a big problem for anyone looking at the stock today.
To paraphrase Benjamin Graham -- one of the men who taught Warren Buffett how to invest -- a good stock can be a bad investment if you overpay for it. The logic is simple, and WD-40 is a great example. Wall Street has a habit of getting overly excited about some stocks. When that happens, the share price tends to go well beyond historical trends because investors extrapolate good news into the future. When such a company fails to live up to what may have been unrealistic expectations, investors can quickly become excessively pessimistic, and dump its shares. That's basically what happened between the fiscal second and third quarters at WD-40.
The problem today is that Wall Street is back to expecting big things from WD-40 -- which you can see when you dig into its valuation metrics. For example, the company's price-to-sales ratio is currently 6.1, compared to its five-year average of 4.3. Its price-to-earnings ratio is 37, compared to a longer-term average of 32 -- not as excessive, but still historically high. The price-to-cash-flow ratio is sitting around 43, well above the five-year average of 31. And WD-40's price-to-book-value ratio of 16 is notably higher than its average of 11.
Any one of these metrics can become temporarily skewed, but in combination, they paint a clear picture: WD-40 is expensive today. The stock's performance between the fiscal second and third quarters pretty much shows that investors are expecting perfection, and if they get anything less, there is likely to be another wave of selling.
Not the right time
WD-40's customer base runs the gamut from the industrial sector to household customers, and as such, it could take a notable hit from a recession. That's a realistic fear now, with the yield curve inverting, the U.S. engaged in an interminable trade war with China, and economic growth weakening across the globe. So with WD-40 trading at expensive valuations, this is not the time to buy in. Investors would be better off waiting for valuations to return to levels at least more in line with their historical range, if not a little below the norm.
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This article was originally published on Fool.com