PENN Entertainment has had an impressive run over the past six months as its shares have beaten the S&P 500 by 26.2%. The stock now trades at $20.16, marking a 37.2% gain. This run-up might have investors contemplating their next move.
Is now the time to buy PENN Entertainment, 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.
Why Do We Think PENN Entertainment Will Underperform?
Despite the momentum, we’re cautious about PENN Entertainment. Here are three reasons we avoid PENN, plus one stock we’d rather own.
1. Long-Term Revenue Growth Disappoints
Examining a company’s long-term performance can provide clues about its quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years. Over the last five years, PENN Entertainment grew its sales at a 13.6% compounded annual growth rate. Although this growth is acceptable on an absolute basis, it fell short of our standards for the consumer discretionary sector, which enjoys a number of secular tailwinds.
2. Breakeven Free Cash Flow Limits Reinvestment Potential
Free cash flow isn’t a prominently featured metric in company financials and earnings releases, but we think it’s telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
PENN Entertainment broke even from a free cash flow perspective over the last two years, giving the company limited opportunities to return capital to shareholders.
3. New Investments Fail to Bear Fruit as ROIC Declines
A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared 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. Unfortunately, PENN Entertainment’s ROIC has decreased significantly over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
Final Judgment
PENN Entertainment doesn’t pass our quality test. With its shares beating the market recently, the stock trades at 20.1× forward P/E (or $20.16 per share). This valuation is reasonable, but the company’s shaky fundamentals present too much downside risk. There are better stocks to buy right now. We’d recommend looking at a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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