Shareholders of ADT would probably like to forget the past six months even happened. The stock dropped 24.4% and now trades at $6.69. This may have investors wondering how to approach the situation.
Is there a buying opportunity in ADT, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Do We Think ADT Will Underperform?
Even though the stock has become cheaper, we're swiping left on ADT for now. Here are three reasons why ADT doesn't excite us and a stock we'd rather own.
1. Long-Term Revenue Growth Flatter Than a Pancake
Examining a company’s long-term performance can provide clues about its quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Unfortunately, ADT struggled to consistently increase demand as its $5.13 billion of sales for the trailing 12 months was close to its revenue five years ago. This was below our standards and signals it’s a low quality business.
2. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
ADT has shown poor cash profitability relative to peers over the last two years, giving the company fewer opportunities to return capital to shareholders. Its free cash flow margin averaged 14.5%, below what we’d expect for a consumer discretionary business.
3. Previous Growth Initiatives Haven’t Impressed
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).
ADT historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 6.7%, somewhat low compared to the best consumer discretionary companies that consistently pump out 25%+.
Final Judgment
ADT doesn’t pass our quality test. Following the recent decline, the stock trades at 7.3× forward P/E (or $6.69 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are better investments elsewhere. Let us point you toward one of our top digital advertising picks.
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