AEIS - Time To Sell Advanced Energy Industries

• The shares are up nicely since I bought them many years ago, but an investment at $93 is a very different thing than an investment at $58.
• Although revenue is up very nicely, net income has lagged. Although I don't think the dividend is in danger, the yield is so low as to be almost irrelevant.
• The shares aren't objectively cheap anymore, and one of the reasons I bought previously is because I was aping the behavior of the great Joel Greenblatt. He's sold since.

I love taking a walk down memory lane sometimes, and I'm going to indulge that desire today by revisiting a stock I bought and wrote about on this forum more than 4 years ago. Today I want to revisit Advanced Energy Industries Inc. ( AEIS ). The shares are up about 61% against a gain of about 53% for the S&P 500 since I posted my bullish piece on this stock way back in June of 2018. Although I love to brag about returns like this, I'm overwhelmed by the fact that rereading that old work reminds me how stiff I used to sound. Walks down memory lane aren't always pleasant. Anyway, I thought I'd review the name again to see if it makes sense to continue holding or not. I'll make the determination by looking at the most recent financial performance here, and by looking at the current valuation. After all, just because this fast grower was a great investment at $58 doesn't mean it's a great investment at $93.

We're all busy people, dear readers. I'm sure all of you have got to figure out how to spend your winnings from the most recent market bump. I've got hundreds of hours of cat videos and Young and the Restless reruns to burn through. So, we're all busy, and for that reason I want to offer you this "thesis statement" paragraph that'll give you the gist of my thinking, and may insulate you from the need to wade through the entire article, being exposed to more "Doyle mojo" than any sane person can bear. While I'm obviously happy with the returns here, I think the good times are largely behind this stock, and so I'll be taking my chips off the table. I'm obviously impressed by the incredible revenue growth, but net income has lagged. Although I think the dividend is reasonably secure, the yield is so low that I'd need for the shares to be cheap to get me excited. They're not cheap, I'm afraid. Additionally, one of the reasons I bought the shares previously is because I rode the coattails of more talented investors than myself. That circumstance has changed, as Joel Greenblatt sold out of this stock in June of 2021. With a nod to the idea that no one ever went broke taking profits, I'll be cashing in my chips this morning. I'll certainly be happy to buy back in at the right price.

Financial Snapshot

The company has grown spectacularly over the past few years obviously. Revenue has more than doubled since I last looked at this business, up from ~$719 million in 2018 to $1.456 billion for the year 2021. What's a bit troubling to me is the fact that net income remains constant in the teeth of these increased sales. The company posted net income of $147 million in 2018, and it was actually lower at $135 million in 2021. Looking at the most recent results, we see that the first six months of 2022 have been mostly better than the same period in 2021, and much better than the same period in 2019. Relative to 2021, revenue and net income were up by 17.6%, and 10.4% respectively for the first half of 2022. Relative to 2019, revenue and net income were 49% and 135% higher respectively.

Although the capital structure has deteriorated somewhat, it's still quite strong in my view. At the moment, for instance, cash and marketable securities represent about 97% of total long term debt. Additionally, debt maturities are only $20 million per year until 2026, at which point the obligation jumps to $315 million. Thus, I don't foresee any threat to the very new dividend at this point. For context, the company spent about $15.4 million on dividend payments in 2021, and has about 25 times that in cash on hand.

So, in spite of the fact that net income growth hasn't kept pace with revenue growth, I'm comfortable with the dividend here, and I'd be willing to add to my small position at the right price.

The Stock

Ah the phrase "at the right price." Those four words have disqualified many, many stocks from consideration because I'm a stickler for trying to not overpay for a given stock. After all a company can grow profits nicely over time, but if you overpay for the investment, you'll likely lose money. This is a painful, but important, lesson for investors to learn: the stock and the company are distinct from each other. We don't actually buy "companies." We buy "stocks."

To clarify, every business buys a number of inputs, performs value-adding activities on them and sells the results at a profit. In the final analysis, that's what every business is. The stock, on the other hand, is an ownership stake in the business that gets traded around in a market that aggregates the crowd's rapidly changing views about the future health of the business. It's also possible that the stock's movements relate to the crowd's view about "the market" in general, and have very little to do with what's going on at the company. This is tedious on some level, but it also presents an opportunity, because these price movements have the potential to create a disconnect between market expectations and subsequent reality. In my experience, this is the only way to generate profits trading stocks: by determining the crowd's expectations about a given company's performance, spotting discrepancies between those assumptions and stock price, and placing a trade accordingly. I've also found it's the case that investors do better/less badly when they buy shares that are relatively cheap, because cheap shares correlate with low expectations. This is why I insist on trying (though not always succeeding as it turns out) to buy shares cheaply.

As my regulars know, I measure the relative cheapness of a stock in a few ways. For example, I like to look at the ratio of price to some measure of economic value, like earnings, sales, free cash, and the like. I like to see a company trading at a discount to both the overall market, and to its own history. Previously, I recommended buying these shares because they were trading at a price to free cash flow of about 14.2 times. Fast forward four years, and here's where things stand today. What a difference 4 years makes:

Source: YCharts

At the same time the shares are neither cheap nor expensive on a price to earnings basis.

The fact that the shares aren't egregiously expensive on a price to earnings basis, but are massively expensive on a price to free cash flow basis puts me on the horns of a dilemma. Do I buy, sell, or hold? Because I'm of the view that avoiding loss is much more important than trying to capture future upside, my initial response is to sell, but I want to look for confirming evidence one way or another.

In case you forgot because it's been a while, another reason I purchased shares over four years ago was because one of my investing heroes (Joel Greenblatt) bought shares. The problem is that he sold out of the stock in June of 2021. Thus, if one of the reasons for my bullishness was the fact that Greenblatt bought, the fact that he has since sold should partially guide actions also.

Also, in addition to all of the above, I want to try to understand what the market is currently "assuming" about the future of this company. If you read me regularly, you know that I rely on the work of Professor Stephen Penman and his book "Accounting for Value" for this. In this book, Penman walks investors through how they can apply the magic of high school algebra to a standard finance formula in order to work out what the market is "thinking" about a given company's future growth. This involves isolating the "g" (growth) variable in a fairly standard finance formula. Applying this approach to Advanced Energy at the moment suggests the market is assuming that this company will grow at a perpetual rate of ~5.8%, which I consider to be very optimistic. Given all of the above, I'll be following Greenblatt and taking my Advanced Energy Industries chips off the table.

Conclusion

Although these shares have done well for me over time, I think it's time to leave the party. The company continues to grow nicely, but net income is lagging behind in my view. Additionally, the dividend may be very secure, but the yield is relatively low. The above suggests to me that it would only make sense to add to the position if the shares were objectively cheap. I've found that they're not objectively cheap. For that reason, I'm going to do what Joel Greenblatt was smart enough to do over a year ago, and finally take my winnings off the table here. If the shares drop in price nicely, I'll certainly buy back in.

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