In investing, there’s a natural tendency to be drawn to familiar names, an emotional comfort zone that comes from thinking about putting your hard-earned dollars into a company to which you feel you have a connection. It’s one of the reason well-known fundamental investors like Peter Lynch are known for suggesting idioms like “invest in what you know.”
The problem, of course with that logic is that the world of business is always changing and evolving; a business that is well-known and established today, for example may no longer exist just a few short years down the road. I’ve been reminded of that reality over the last few years as I’ve watched well-known and respected names in the retail world disappear altogether or come tottering to the brink of oblivion. Toys R Us, J.C. Penney and Sears & Roebuck are just a few examples of companies, and stocks that most of us would probably have previously thought of as bastions of American enterprise, benchmarks of market stability and strength. Toys R Us, of course is gone, and both J.C. Penney and Sears, despite more than a century in operation, are in such apparent disarray that nobody seems to expect them to survive. What’s in a name? Sometimes, not much at all.
That’s a pretty grim introduction to today’s highlight – but I’m deliberately trying to overemphasize one of the reasons that I think we have to be careful as investors getting too caught up in the idea that a stock might be a good investment, just because we are familiar with the company or because we like their products. WD-40 Company (WDFC) is one of those names that I think everybody can recognize immediately. They’ve been around for more than 65 years, which is attributable in no small part to the reality that when you think about household goods for all kinds of problems or projects, WD-40 is probably on your shortlist of must-haves. That is a fact that has helped this small-cap company not only survive, but excel in its market niche. By a number of fundamental measurements, the stock is very solid; but at around $164 right now, is it a good value? That is another question altogether.
Fundamental and Value Profile
WD-40 Company is a global company engaged in developing and selling products, which solve problems in workshops, factories and homes. The Company’s segments include the Americas; Europe, Middle East and Africa (EMEA), and Asia-Pacific. The Company’s Americas segment includes the United States, Canada and Latin America. The EMEA segment includes countries in Europe, the Middle East, Africa and India. The Asia-Pacific segment includes Australia, China and other countries in the Asia region. The Company has two product groups, which include maintenance products and homecare and cleaning products. As of August 31, 2016, the Company marketed and sold its products in more than 176 countries and territories around the world primarily through mass retail and home center stores, warehouse club stores, grocery stores, hardware stores, automotive parts outlets, sport retailers, independent bike dealers, online retailers and industrial distributors and suppliers. WDFC has a current market cap of about $2.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by 5.5%, while revenue also increased by a little less than 4%. In the last quarter, earnings declined -7.77%, while sales were mostly flat, but negative, at -1.32%. WDFC operates with a very healthy margin profile; over the last twelve months, Net Income was 16.2% of Revenues. That number decreased slightly to 15.7% in the last quarter. Both measurements are a good sign of strength.
Free Cash Flow: Over the last twelve months, WDFC had $49 million in Free Cash Flow. That’s mostly unremarkable, but adequate and translates to a Free Cash Flow Yield of a little over 2%.
Debt/Equity: WDFC’s debt to equity ratio is .41, which is pretty low and suggests that management follows a conservative approach to debt. Their balance sheet shows about $32 million in cash and liquid assets against roughly $63 million in long-term debt. The margin profile is a good indication that servicing their debt is no problem, and given the company’s size, liquidity shouldn’t be a concern.
Dividend: WDFC’s dividend is $2.44 per share and translates to an annual yield of about 1.5%% at the stock’s current price.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for WDFC is $10.98 and translates to a Price/Book ratio of 14.89 at the stock’s current price. The stock’s historical average Price/Book ratio is 13.3, meaning that the stock is currently overvalued, by almost -11%. That’s a little deflating, but supported by the fact that the stock is currently trading about -12% above its historical Price/Cash Flow ratio. Together, the “fair value” for WDFC is somewhere between $142 and $146 per share.
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s long-term upward trend. This is a stock that has bucked the broader market trend since the beginning of the year, after a practically uninterrupted rise over the last ten years from around $25 per share. The red line also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock is down about -11% so far this year after hitting a peak around $187 at the end of December, but is still more than $10 above the 38.2% retracement line. It is interesting to me that the 50% retracement line is around $144, which is about where the stock’s valuation measurements put the stock’s fair value. The stock would have to break above the $175 level, where previous pivots currently appear to be acting as resistance right now, in order to stage any kind of new, sustainable upward trend. The stock’s recent gap lower seems to make that unlikely, with a much greater likelihood the stock will test support at the 38.2% retracement line.
Near-term Keys: Working off of the stock’s historical Price/Book and Price/Cash Flow ratio puts a “bargain” price for WDFC at around $115 per share, which is just a little above the 88.6% retracement line. That marks a big drop from the stock’s current price, and represents a lot of downside that I think should make any sensible long-term investor stay away from the stock. The fundamentals for the company are good, but simply not robust enough to justify the stock’s current elevated price. This is a small-cap stock that is currently being priced like a large-cap stock. I don’t expect that continue to be true. That also means that I don’t there are any good probabilities for bullish trades right now; on a short-term basis, the best bet is to short the stock, or work with put options with a near-term target price at around $155 per share, where I think the stock should test support in the near future.