3 Reasons DNOW is Risky and 1 Stock to Buy Instead

Over the past six months, DistributionNOW has been a great trade, beating the S&P 500 by 5.4%. Its stock price has climbed to $14.81, representing a healthy 9.1% increase. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.

Is there a buying opportunity in DistributionNOW, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.

Why Do We Think DistributionNOW Will Underperform?

We’re glad investors have benefited from the price increase, but we don't have much confidence in DistributionNOW. Here are three reasons why we avoid DNOW and a stock we'd rather own.

1. Revenue Spiraling Downwards

Reviewing a company’s long-term sales performance reveals insights into its quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years. Over the last five years, DistributionNOW’s demand was weak and its revenue declined by 2.8% per year. This was below our standards and signals it’s a low quality business.

2. EPS Took a Dip Over the Last Two Years

While long-term earnings trends give us the big picture, we also track EPS over a shorter period because it can provide insight into an emerging theme or development for the business.

Sadly for DistributionNOW, its EPS declined by 6.3% annually over the last two years while its revenue grew by 3.5%. This tells us the company became less profitable on a per-share basis as it expanded.

3. 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, DistributionNOW’s margin dropped by 4.8 percentage points over the last five years. If its declines continue, it could signal increasing investment needs and capital intensity. DistributionNOW’s free cash flow margin for the trailing 12 months was 7.8%.

Final Judgment

We see the value of companies helping their customers, but in the case of DistributionNOW, we’re out. With its shares topping the market in recent months, the stock trades at 10.2× forward EV-to-EBITDA (or $14.81 per share). This valuation tells us a lot of optimism is priced in - you can find more timely opportunities elsewhere. We’d suggest looking at the most dominant software business in the world.

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