There is a pretty significant difference in the way different investors perceive a stock in a long-term upward trend. For growth oriented-investors, the longer the upward trend, the more attractive the stock is, simply because the expectation is that the longer, bullish trend will outlast any near-term, bearish sentiment or momentum the stock may see. On the other hand, a stock in an upward trend – especially a long-term one – is something that leads value-oriented investors to shun it. That is especially true if, like me, they also tend to operate with a bit of a contrarian view of the world.
The challenge for value investors is that sometimes, a stock in a long downward trend has a very good reason for being where it is – sometimes, a cheap stock is just a cheap stock. Efficient market theory holds that in the broadest sense, the market is very good at pricing a company’s underlying fundamental weakness or strength into a stock’s price. That is often very much the case, which is why it is important to always be careful about considering a stock in a long-term downward trend for any kind of bullish position. It’s why I concentrate not only on a stock’s value proposition, but also make sure to run through a detailed view of the company’s business.
For stocks in long-term upward trends, efficient market theory holds that the most likely reason for the increase is the fundamental strength of the underlying business, which naturally attracts more investors to it. The problem with that notion for value investors is that, more often than not, a stock’s increase in price during a long-term upward trend tends to significantly outpace any increase or growth in the company’s actual business or improvement in the bottom line. If sales and earnings increase 10%, for example, a stock’s comparative increase in price will often be 2.5 to 3 times higher. At some point, the stock is simply too expensive to justify an investment.
The Mosaic Company (MOS) is a company in the Materials sector I’ve followed for some time that has followed the broad market over the past year, with an upward trend that from July of last year to a peak at the start of this month has seen the stock more than triple in value. From that peak a couple of weeks ago above $38, however, the stock has since dropped more than -20%, running right around $30 as of this writing. That kind of drop can signal potential problems, but considering the speed of the drop, is often simply reflective of the same investor tendency to overreact to news and events – which is why drops like this also tend to pique the interest of bargain hunters like myself. What do the company’s fundamentals say about how much the stock should be worth? Let’s find out.
Fundamental and Value Profile
The Mosaic Company is a producer and marketer of concentrated phosphate and potash crop nutrients. The Company operates through three segments: Phosphates, Potash and International Distribution. The Company is a supplier of phosphate- and potash-based crop nutrients and animal feed ingredients. The Phosphates segment owns and operates mines and production facilities in Florida, which produce concentrated phosphate crop nutrients and phosphate-based animal feed ingredients, and processing plants in Louisiana, which produce concentrated phosphate crop nutrients. The Potash segment mines and processes potash in Canada and the United States, and sells potash in North America and internationally. The International Distribution segment markets phosphate-, potash- and nitrogen-based crop nutrients and animal feed ingredients, and provides other ancillary services to wholesalers, cooperatives, independent retailers and farmers in South America and the Asia-Pacific regions. MOS has a current market cap of about $11.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased more 1,000% (not a typo), while revenues improved by 27.75%. In the last quarter, earnings growth was exactly 0%, while sales declined -6.52%. The company’s margin profile has been health over the past year, but is starting to show signs of deterioration; Net Income as a percentage of Revenues declined from 11.17% over the last twelve months to 6.82% in the last quarter.
Free Cash Flow: MOS’s free cash flow over the last twelve months is $515.8 million. That’s an improvement over the last two quarters, this number was $498 million in the third quarter of 2020. The current number also translates to a Free Cash Flow Yield of 4.16%.
Debt to Equity: MOS has a debt/equity ratio of .41. This is a conservative number. MOS currently has $692 million in cash and liquid assets against about $3.9 billion in long-term debt. The company’s balance sheet indicates their operating profits are adequate to service the debt they have, however the company’s deteriorating Net Income profile suggests that if that measurement doesn’t improve, their liquidity could decrease even more.
Dividend: MOS’s annual divided is minimal, at only $.30 per share; that translates to a yield of just 0.99% 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 I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $23.50 per share. That means that even with the stock’s drop so far, MOS remains overvalued, with about -22% downside from its current price, and a useful bargain price sitting a little below $19.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red line on the chart above outlines the stock’s upward trend from July of last year to its peak at the beginning of June; it also informs the Fibonacci retracement levels on the right side of the chart. The drop has the stock just a couple of dollars above expected, current support at around $28 where the 38.2% retracement line sits. It could also find support around $30 from previous pivot activity in its current price range from March and April. A drop below $28 should see additional downside to about $24, a little below the 50% retracement line and consistent with pivot activity seen at the end of 2020. Immediate resistance looks to be at about $32, which also marks the minimum level the stock would need to move past to begin reversing the current bearish short-term trend; a push above that mark should see next resistance at around $34.
Near-term Keys: MOS’ current momentum is clearly bearish, and the widening range between downside versus upside in the stock actually makes any kind of bullish near-term trade very speculative in this stock. The best probabilities lie in bearish trades right now; use a drop below $30 to consider shorting the stock or buying put options, using $28 as a quick-hit profit target and $24 if bearish momentum accelerates. While MOS does have some interesting elements of fundamental strength, its declining Net Income pattern is a concern that supports the fact that MOS remains overvalued right now. Long-term investors should tuck this stock away for now and come back to take another look in a quarter or two.