Over the past six months, Methode Electronics’s shares (currently trading at $6.76) have posted a disappointing 10.2% loss, well below the S&P 500’s 11.3% gain. This might have investors contemplating their next move.
Is now the time to buy Methode Electronics, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free for active Edge members.
Why Do We Think Methode Electronics Will Underperform?
Even with the cheaper entry price, we're cautious about Methode Electronics. Here are three reasons we avoid MEI and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
Reviewing a company’s long-term sales performance reveals insights into its quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years. Regrettably, Methode Electronics’s sales grew at a sluggish 1.7% compounded annual growth rate over the last five years. This was below our standards.
2. Free Cash Flow Margin Dropping
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.
As you can see below, Methode Electronics’s margin dropped by 11.6 percentage points over the last five years. This along with its unexciting margin put the company in a tough spot, and shareholders are likely hoping it can reverse course. If the trend continues, it could signal it’s in the middle of a big investment cycle. Methode Electronics’s free cash flow margin for the trailing 12 months was breakeven.
3. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Methode Electronics’s ROIC has unfortunately decreased significantly. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
Final Judgment
Methode Electronics doesn’t pass our quality test. Following the recent decline, the stock trades at 3.1× forward EV-to-EBITDA (or $6.76 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are better stocks to buy right now. We’d suggest looking at a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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