When I see stocks trading at or near historical highs I almost always assume that the stock is overvalued. That’s even more true if the stock is near to an all-time high and has been following an upward trend of more than a year. A similar, opposite logic applies to stocks in a downward trend; the longer the trend has extended to the downside, the more I tend to wonder if the stock might be worth taking more seriously. This is a mindset that is more than a little different from most growth-oriented investing methods, which is why value-driven investors like me are often called contrarians.
One of the reasons trends covering different time periods is important to recognize is that over those differing time ranges, the factors that carry the greatest weight isn’t always the same. Some trends are driven primarily by nothing more than current news, market sentiment and the ebb and flow of current momentum. That’s true of short-term trends. What I like to call intermediate-term trends – those that cover three to nine months, roughly – also reflects some of the same influences as short-term trends, but are often also dictated by other, somewhat broader factors, like industry or sector momentum. Longer trends, which generally cover a year or more, are usually influenced the most by national and global economic shifts and trends, and on an individualized basis, also by a company’s fundamental strength.
When you get the combination of a growing, healthy economy along with a fundamentally solid company with a growing business, it’s pretty normal to see that company’s stock price trading at or near historical highs. That’s because investors will recognize the company’s ability to grow their business and jump on board for the ride. That can obviously put the stock in overbought, overvalued territory at the extreme; but one of the things that can also happen in some cases is that the stock’s higher price really just reflects the increasing intrinsic value of the underlying business. A stock in a long, downward trend usually has investors staying away, because some of the same logic applies, again in reverse: the downward trend can be influenced by weakening fundamentals, and if that is the case, the stock’s price should logically be lower.
This is an idea that lies at the heart of value investing; a company with a growing business should naturally offer greater and greater returns to stakeholders. In a private company, that usually means that the portion of profits distributed to those stakeholders should grow each year that the business grows. In a publicly traded company, the most tangible way that growth gets back to stakeholders is by an increase in the stock’s trading price. Often, however a stock trading at historical lows is being driven by simple market momentum and broader economic factors that are outside of management’s control; but when you drill down into the company’s details, you may be able to clearly see that the intrinsic value of the company is higher than the stock’s price. This is the sweet spot for value investors like me, and it’s why I get more interested when I see a stock dropping significantly off of historical highs.
Agilent Technologies, Inc. (A) is a company that could fit this description right now. This is a stock that has spent most of the past six months in a significant downward trend, falling from a peak in September at around $180 to its current price around $130. That’s more than -30% from that high and marking a legitimate bear market for this stock that doesn’t look ready to reverse. The question, of course is whether that -30% drop is enough to mark a useful value price for the stock now, or whether there is more downside ahead. Let’s dive in.
Fundamental and Value Profile
Agilent Technologies, Inc. (A) provides application focused solutions that include instruments, software, services and consumables for the entire laboratory workflow. The Company serves the life sciences, diagnostics and applied chemical markets. It has three business segments: life sciences and applied markets business, diagnostics and genomics business, and Agilent CrossLab business. Its life sciences and applied markets business segment offers instruments and software that enable customers to identify, quantify and analyze the physical and biological properties of substances and products, as well as enable customers in the clinical and life sciences research areas to interrogate samples at the molecular level. Its diagnostics and genomics business segment includes the reagent partnership, pathology, companion diagnostics, genomics and the nucleic acid solutions businesses. Its Agilent CrossLab business segment spans the entire lab with its consumables and services portfolio. A has a current market cap of about $38.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings and revenues both increased, with earnings growing 14% and sales by about 8%. In the last quarter, earnings were flat, at exactly 0% while sales were slightly positive, at 0.84%. The company’s margin profile weakened in the last quarter compared to the trailing twelve months, from almost 19% (TTM) to just a little above 15% (quarter). The company’s operating margins are healthy, but showing some weakness;
Free Cash Flow: A’s free cash flow is modest, at $1.28 million. Free Cash Flow has also increased steadily since the second quarter of 2015 from a little over $200 million, and been stable for the past year around $1.25 billion. That translates to a Free Cash Flow Yield of 3.37%.
Debt to Equity: A has a debt/equity ratio of .53. This is generally conservative and implies a manageable approach to leverage. The company’s cash and liquid assets were $1.15 billion in the last quarter against $2.7 billion in long-term debt. The company’s margin profile indicates servicing their debt shouldn’t be a problem.
Dividend: A pays an annual dividend of $.84 per share, which translates to a yield of 0.68% at the stock’s current price. While that sounds unremarkable, it is worth noting that most technology-driven companies do not pay a dividend at all.
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 $112 per share. That means that A is is overvalued by about -12% right now, with a useful discount price at around $89.50 per share.
Technical Profile
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 downward trend, and also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock found a trend bottom at around $123 in late February, and retested that low again to start this week, marking current support at that level, with immediate resistance expected at around $131. The distance between current support and immediate resistance also provide a reference for how much additional, near-term downside the stock could have if it falls below $123; look for next support at around $115. A push above $131 should find next resistance at around $140, with additional upside to about $145 where the 38.2% retracement line waits if buying activity continues. The stock would need to break $145 to confirm a long-term bullish trend reversal.
Near-term Keys: If the stock continues to move higher off of current support, and you don’t mind being speculative, there could be an opportunity to either buy the stock or start working with call options. A conservative approach could be start with a smaller than normal position size with a $$140 target in mind; if the stock reaches that point, but continues to show strong bullish strength you could consider adding to the position at that point. If the stock drops below $123, you should avoid any kind of bullish position. That would signal a confirmation and likely extension of the current downward trend, and could provide an opportunity to think about shorting the stock or to buy put options, with $115 providing a practical profit target on a bearish trade.