David Trainer, CEO of New Constructs, identifies three stocks to avoid: Zoe's Kitchen, Kansas City Southern, and Blackbaud. He warns that these companies rely on aggressive non-GAAP metrics and assume unrealistic profit growth, leaving them vulnerable when reality doesn't match the hype.
Chapters
But today we're looking at what our guest calls some dangerous stocks that you might want to stay away from.
And joining us now is David Trainer, CEO of New Constructs. David, welcome.
Thank you.
So let's go through your list here. Zoe's Kitchen, you say no meat on the bone for this restaurant concept, which already has a pretty ugly looking chart. What's your case?
I think the fast casual dining is a crowded space and Look, they're actually losing a lot of money. We show over $100 million in negative cash flow over the last couple of years. But what really gets us is the stock price. Just because it's gone down a lot doesn't mean it's not cheap. To justify the current price, they've got to grow profits at about 10% for nearly 35 years. So that's, that's a lot of growth to be baked into a stock price.
Are you short that stock, by the way?
I'm not.
Okay. Kansas City Southern, you call the most expensive of the rails that you follow. But if the economy picks up, shouldn't it be?
Right. But you have to think about how much is already priced in, right? I mean, the stock price implies the profits are going to triple. Or another way to think about that is 7% growth for about 20 years. I mean, where's the upside, right? I think investors are so desperate to find attractive stocks that they're plowing money into a lot of stocks where they shouldn't be. And when you look under the covers of these companies, the profits are not as good as the accounting or the non-GAAP numbers suggest.
So, Mike, either go for either Zoe's Kitchen or Kansas City.
Yeah, I mean, obviously they're both— they both have premium valuations relative to what the peers do. And David, I guess I would ask you the question. I mean, you're looking at certain measures of earnings quality, but they're not necessarily measures that are secrets to the rest of the market. In other words, is the market kind of building in something else here in either of these cases? For example, you could see them down the road being acquisition candidates.
That's right. I mean, you look, we have a section in all of our reports on dangerous stocks called Stupid Money Risk. And we see all the time companies, you know, Microsoft and LinkedIn. Nobody understood that, right? Sometimes a big company needs to buy a small company just to be interesting. That can happen. But that's a big bet, right? If you're betting on somebody to buy out your stock in order for you to make money, is that really risk you want to carry in your portfolio? Do you want to own things for really solid fundamental reasons?
Last one before we let you go. Not exactly a household name, a company called Blackbaud. Tell us about it.
Yeah, well, they provide software to the nonprofit industry, but that doesn't mean that they're a nonprofit, right? It's a stock. And, and again, this is a company that, you know, really raises a lot of red flags when companies really try to get you to focus on non-GAAP earnings. We see that's a red flag. It's a lot of what we saw with companies like Valeant and others that have since blown up. And the bottom line is they're not making any money. They're losing a lot of money despite showing investors that they are making a lot of money. And again, the valuation, really scary. 10% profit growth for over 40 years. Not many software companies in the history of the world have ever done that or will ever do that. Do you want to carry that kind of risk in your portfolio?
Stock's up 72% in the last 3 years.
Non-GAAP hasn't been a problem so far.
Until it is, right?
Just—
that's what we thought with Vale. It wasn't a problem until it was. You can't pay your bills with non-GAAP earnings.
