Although Methode Electronics (currently trading at $10.98 per share) has gained 7.5% over the last six months, it has trailed the S&P 500’s 16.8% return during that period. This 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? See what our analysts have to say in our full research report, it’s free.
We're sitting this one out for now. Here are three reasons why MEI doesn't excite us and a stock we'd rather own.
Why Do We Think Methode Electronics Will Underperform?
Founded in 1946, Methode Electronics (NYSE:MEI) is a global supplier of custom-engineered solutions for Original Equipment Manufacturers (OEMs).
1. Long-Term Revenue Growth Flatter Than a Pancake
A company’s long-term performance is an indicator of its overall quality. While any business can experience short-term success, top-performing ones enjoy sustained growth for years. Unfortunately, Methode Electronics struggled to consistently increase demand as its $1.09 billion of sales for the trailing 12 months was close to its revenue five years ago. This fell short of our benchmarks and is a sign of poor business quality. 
2. 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.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Methode Electronics burned through $33.1 million of cash over the last year, and its $374.5 million of debt exceeds the $97 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Methode Electronics’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Methode Electronics until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
Methode Electronics doesn’t pass our quality test. With its shares trailing the market in recent months, the stock trades at 23.8× forward price-to-earnings (or $10.98 per share). At this valuation, there’s a lot of good news priced in - we think there are better opportunities elsewhere. Let us point you toward a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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