What a brutal six months it’s been for Methode Electronics. The stock has dropped 30.3% and now trades at $7.48, rattling many shareholders. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.
Is there a buying opportunity in Methode Electronics, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Do We Think Methode Electronics Will Underperform?
Even though the stock has become cheaper, we're cautious about Methode Electronics. Here are three reasons why you should be careful with MEI and a stock we'd rather own.
1. Long-Term Revenue Growth Flatter Than a Pancake
A company’s long-term sales performance can indicate its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Unfortunately, Methode Electronics struggled to consistently increase demand as its $1.07 billion of sales for the trailing 12 months was close to its revenue five years ago. This wasn’t a great result and signals it’s a low quality business. 
2. Free Cash Flow Margin Dropping
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.
As you can see below, Methode Electronics’s margin dropped by 19.6 percentage points over the last five years. This along with its unexciting margin put the company in a tough spot, and shareholders are likely hoping it can reverse course. If the trend continues, it could signal it’s becoming a more capital-intensive business. Methode Electronics’s free cash flow margin for the trailing 12 months was negative 2.4%.
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, Methode Electronics’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
We cheer for all companies making their customers lives easier, but in the case of Methode Electronics, we’ll be cheering from the sidelines. Following the recent decline, the stock trades at 11.2× forward P/E (or $7.48 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 suggest looking at one of our top software and edge computing picks.
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