Over the past six months, A. O. Smith’s stock price fell to $57.98. Shareholders have lost 8.4% of their capital, which is disappointing considering the S&P 500 has climbed by 11.5%. This was partly driven by its softer quarterly results and might have investors contemplating their next move.

Is now the time to buy A. O. Smith, or should you be careful about including it in your portfolio? See what our analysts have to say in our full research report, it’s free.

Why Is A. O. Smith Not Exciting?

Despite the more favorable entry price, we're swiping left on A. O. Smith for now. Here are three reasons we avoid AOS and a stock we'd rather own.

1. Long-Term Revenue Growth Disappoints

A company’s long-term performance is an indicator of its overall quality. Any business can have short-term success, but a top-tier one grows for years. Regrettably, A. O. Smith’s sales grew at a tepid 4.7% compounded annual growth rate over the last five years. This fell short of our benchmark for the industrials sector.

2. EPS Took a Dip Over the Last Two Years

Although long-term earnings trends give us the big picture, we like to analyze EPS over a shorter period to see if we are missing a change in the business.

Sadly for A. O. Smith, its EPS declined by 1.6% annually over the last two years. We tend to steer our readers away from companies with falling revenue and EPS, where diminishing earnings could imply changing secular trends and preferences. If the tide turns unexpectedly, A. O. Smith’s low margin of safety could leave its stock price susceptible to large downswings.

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, A. O. Smith’s ROIC has decreased 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

A. O. Smith isn’t a terrible business, but it doesn’t pass our bar. After the recent drawdown, the stock trades at 14.6× forward P/E (or $57.98 per share). This valuation is reasonable, but the company’s shakier fundamentals present too much downside risk. We're fairly confident there are better stocks to buy right now. We’d recommend looking at a fast-growing restaurant franchise with an A+ ranch dressing sauce.

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