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Sornette, Predictions, And Why To Avoid Harsco

Summary

We're humble enough to admit that we can't point to the exact thing that will cause an overvalued stock to crash (much to the chagrin of some of our readers).

That's why we try to avoid predicting the future, and avoid others' overoptimistic predictions. And Harsco's price-implied earnings growth rate of ~3,550% is, in our opinion, too optimistic.

Harsco has low margins, anemic revenue, and over-optimistic earnings assumptions. Avoid.

In describing stock market crashes, Didier Sornette draws a great analogy:

Think of a ruler held up vertically on your finger: this very unstable position will lead eventually to its collapse, as a result of a small (or an absence of adequate) motion of your hand or due to any tiny whiff of air. The collapse is fundamentally due to the unstable position; the instantaneous cause of the collapse is secondary. In the same vein, the growth of the sensitivity and the growing instability of the market close to such a critical point might explain why attempts to unravel the local origin of the crash have been so diverse. Essentially, anything would work once the system is ripe.

We can't predict the future. We're humble enough to admit that we can't point to the exact thing that will cause an overvalued stock to crash (much to the chagrin of some of our readers). In fact, we recommend that you be very, very wary of those who make bold, overconfident predictions, as most predictions fail:

People are really bad at predicting the future. This very much includes experts. In the largest and best-known test of the accuracy of expert predictions, a study reported in Philip Tetlock's book, the average expert was found to be only slight more accurate than a dart-throwing chimpanzee. Many experts would have done better if they had made random guesses.

That's why we make it a point to try to avoid predicting the future, and also to avoid others' overoptimistic predictions. In that vein, we avoid overvalued stocks that trade significantly above the 1920-1990 market's P/E ratio averages - 10 to 20 times. Given that almost half of stocks lose the majority of their peak value, and that most stocks are market losers, we think that's fair.

That brings us to the highly priced Harsco Corporation (NYSE:HSC), which provides industrial services and engineered products in three segments: Metals & Minerals, Rail and Industrial.

The Good

  • HSC sports an extraordinarily high yield of 8.69%, higher than the steel and iron industry average of 6.69%. At some point, that dividend may buoy the stock against significantly lower drops, but only if the dividend is sustainable.
  • It has a positive operating margin, at 5.17%.
  • We're generally quite bullish on the rail industry, and HSC has a segment that maintains, repairs and constructs railway track.

Unfortunately, that's about all we like about HSC.

The Bad

  • Its fundamentals are terrible virtually across the board, with negative ROA (-0.01%) and negative ROE (-0.03%).
  • Similarly, HSC has a negative profit margin (-0.01%). Such a low profit margin is risky, because that profit isn't secure, becoming increasingly sensitive to any further decline in the company's sales.
  • That's particularly problematic when its revenue ($1.92B) has been on the decline for the past several years, with anemically low net income ($-0.12M). TTM declines are -36% and -102%, respectively, for the last five years. HSC is failing to convert its revenue into profit for its shareholders.
  • Its CEO compensation seems a little high - with, for example, CEO F. Nicholas Grasberger III's 2014 total compensation at $4,116,739 - which seems particularly high given the company's poor one-year performance.

Source: Morningstar

As investors, we like to look for companies with a disconnect between high or improving fundamental value and low price-implied expectations. Unfortunately for HSC shareholders, we feel its margins are too thin and expectations are too high.

To analyze whether investors are paying too much for the future earnings of a stock, we reverse-engineer a company's future performance expectations by breaking apart the assumptions built into its current stock price.

With a high P/E of 478.25 and a low forward P/E of 13.12, HSC has a one-year price-implied earnings growth rate of ~3,550%.

In our opinion, that's extraordinarily high. Especially for a company with a checkered past of missing on earnings.

Source: Zacks

Conclusion

We think there's good reason that several market pros have sold out of HSC completely in recent times.

Source: GuruFocus

When it comes to investing, we try not to predict the future, and we avoid others' overoptimistic predictions. Simply, we avoid companies with over-optimistic expectations like the plague. Instead, we look for companies that grow shareholder value at a cheap price.

In our opinion, HSC's expectations are way too high.

Investors should always be wary of too-high price-implied expectations and too-low fundamental value. And despite its high dividend, with its low margins and high price-implied earnings growth rate of ~3,550%, HSC presents too much risk to shareholders. If you own, sell; if you don't own, avoid.


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