The past six months have been a windfall for AAON’s shareholders. The company’s stock price has jumped 67.4%, hitting $126.70 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
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Why Is AAON Not Exciting?
We’re happy investors have made money, but we’re cautious about AAON. Here are three reasons why there are better opportunities than AAON, plus one stock we’d rather own.
1. EPS Took a Dip Over the Last Two Years
While long-term earnings trends give us the big picture, we also track EPS over a shorter period because it can provide insight into an emerging theme or development for the business.
Sadly for AAON, its EPS declined by 18.7% annually over the last two years while its revenue grew by 17.8%. This tells us the company became less profitable on a per-share basis as it expanded.
2. Cash Burn Ignites Concerns
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.
AAON’s demanding reinvestments have drained its resources over the last five years, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 2.7%, meaning it lit $2.65 of cash on fire for every $100 in revenue. This is a stark contrast from its operating margin, and its investments in working capital/capital expenditures are the primary culprit.
3. New Investments Fail to Bear Fruit as ROIC Declines
We like to invest in businesses with high returns, but the trend in a company’s ROIC can also be an early indicator of future business quality.
On average, AAON’s ROIC decreased by 4 percentage points annually each year over the last few years. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
Final Judgment
AAON isn’t a terrible business, but it doesn’t pass our bar. After the recent rally, the stock trades at 55.2× forward P/E (or $126.70 per share). At this valuation, there’s a lot of good news priced in - we think there are better stocks to buy right now. We’d suggest looking at the most dominant software business in the world.
Stocks We Would Buy Instead of AAON
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