H&R Block, Inc. and Light & Wonder

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The most attractive stocks (-6.8%) underperformed the S&P 500 (-3.9%) from May 4, 2022 to May 31, 2022 by 2.9%. The best performing large cap stocks gained 5% and the best performing small cap stocks rose 13%. Overall, 16 of the 40 most attractive stocks outperformed the S&P 500.

The most dangerous stocks (-1.8%) underperformed the S&P 500 (-3.9%) as a short portfolio from May 4, 2022 to May 31, 2022 by 2.1%. The best performing short large cap stocks fell 22% and the best performing short small cap stocks fell 24%. Overall, 12 of the 33 most dangerous stocks outperformed the S&P 500 as shorts.

The most attractive/dangerous model portfolios underperformed the equally weighted long/short portfolios by 5.0%.

Seventeen new stocks made the most attractive list this month, and 22 new stocks also fell on the most dangerous list.

The most attractive stocks have high and growing returns on invested capital (ROIC) and low economic price-to-book ratios. Most dangerous stocks have misleading earnings and long periods of growth appreciation implied by their stock market valuations.

Feature of most attractive stocks for June: H&R Block, Inc.

H&R Block, Inc. (HRB) is the featured stock in June’s Most Attractive Stock Model Portfolio.

H&R Block has grown revenue by 2% compounded annually and net operating income after tax (NOPAT) by 7% compounded annually over the past five years. The company’s NOPAT fell to $156 million during the COVID-19 pandemic in fiscal 2020 (FYE is 4/30), but has since recovered to $1.2 billion in the past few months. last twelve months (TTM). H&R Block’s NOPAT margin increased from 15% in fiscal 2016 to 26% TTM, while investment turnover increased from 1.0 to 1.7 in the same period. Rising NOPAT margins and invested capital turnover increase the company’s return on invested capital (ROIC) from 14% in FY16 to 43% TTM.

Figure 1: Revenue and NOPAT since fiscal year 2016

H&R Block is undervalued

At its current price of $36/share, HRB has an economic price-to-book (PEBV) ratio of 0.3. This ratio means that the market expects H&R Block’s NOPAT to decline permanently by 70%. This expectation seems overly pessimistic for a company that has increased NOPAT by 7% compounded annually over the past five years and 4% compounded annually over the past ten years.

Even if H&R Block’s NOPAT margin falls to 15% (equal to the 20-year average, from 26% TTM) and the company’s NOPAT declines by 1% compounded annually for the next decade, the stock is worth 57 $/share today – a 58% upside. Discover the calculations behind this reverse DCF scenario. If H&R Block increases earnings more in line with historical levels, the stock has even more potential.

Critical Details Found in Financial Documents by My Company’s Robo-Analyst Technology

Below are details of the adjustments I make based on Robo-Analyst’s findings in H&R Block’s 10-Qs and 10-Ks:

Income statement: I made adjustments of $244 million, with the net effect of removing $43 million in non-operating expenses (1% of revenue).

Balance sheet: I made adjustments of $1.7 billion to calculate invested capital with a net decrease of $244 million. One of the most notable adjustments was $735 million in asset write-downs. This adjustment represented 30% of the published net assets.

Valuation: I made adjustments of $3.2 billion, which had the net effect of reducing shareholder value by $1.6 billion. One of the most notable shareholder value adjustments was $805 million in excess cash. This adjustment represents 14% of H&R Block’s market cap.

Characteristic of the most dangerous stocks: Light & Wonder Inc.

Light & Wonder Inc (LNW) is the featured stock in June’s Most Dangerous Stocks model portfolio.

Light & Wonder’s economic profit, the company’s true cash flow, fell from -$76 million in 2017 to -$213 million on the TTM. The company’s NOPAT margin fell from 13% to 8%, while invested capital turnover fell from 0.4 to 0.3 during the same period. Lower NOPAT margins and turnover of invested capital drive Light & Wonder’s ROIC from 5% in 2017 to 2% TTM.

Figure 2: Economic benefits since 2017

Light & Wonder offers poor risk/reward

Despite its poor fundamentals, Light & Wonder is priced for significant earnings growth, and I think the stock is overvalued.

To justify its current price of $56/share, Light & Wonder needs to improve its NOPAT margin to 17% (all-time high in 2019, from 8% TTM) and grow revenue by 7% compounded annually for the next decade. Discover the calculations behind this reverse DCF scenario. In this scenario, Light & Wonder increases the NOPAT by 15% compounded annually over the next ten years. Given that Light & Wonder’s NOPAT has dropped 72% since 2019, I think those expectations seem overly optimistic.

Even if Light & Wonder can achieve a NOPAT margin of 12% (five-year average) and grow revenue by 6% per year over the next decade, the stock is only worth $8/share today, a down 86% from the current title. the price. Discover the calculations behind this reverse DCF scenario. If Light & Wonder’s revenue grew at a slower rate, the title would have even more downsides.

Each of these scenarios also assumes that Light & Wonder can increase revenue, NOPAT, and FCF without increasing working capital or fixed assets. This assumption is unlikely, but allows me to create true best-case scenarios that demonstrate how high the high expectations built into the current valuation are.

Critical Details Found in Financial Documents by My Company’s Robo-Analyst Technology

Below are details of the adjustments I make based on Robo-Analyst’s findings in Light & Wonder’s 10-Qs and 10-Ks:

Income statement: I made adjustments of $1.6 billion, with a net effect of removing $189 million of non-operating revenue (9% of revenue).

Balance sheet: I made adjustments of $5.9 billion to calculate invested capital with a net increase of $333 million. One of the most notable adjustments was the $2.3 billion in net assets from discontinued operations. This adjustment represents 33% of published net assets.

Valuation: I made adjustments of $11.4 billion, with a net decrease in shareholder value of $7.3 billion. Besides the total debt and net assets from discontinued operations mentioned above, the most notable shareholder value adjustment was $396 million in excess cash. This adjustment represents 7% of Light & Wonder’s market cap.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation for writing about a specific stock, style, or theme.

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