2023-03-21 13:10:00 ET
Summary
- I think the most recent financial results from Wiley & Sons have been "lackluster" to put it mildly. The company is far less profitable than it was back in 2019.
- In some ways, the shares are inexpensive, but they're not cheap enough in my view to justify the risks present.
- Investors seek "risk-adjusted" returns, not just returns. In a world where you can get 200 basis points more risk-free, why would you buy this?
It's been almost exactly three months since I wrote my " avoid " piece on John Wiley & Sons Inc. (WLY), and in that time the shares have returned -5% against a gain of about 3.4% for the S&P 500. As I wrote previously, I'd be happy to buy the shares "at the right price", given that I've happily traded this stock over the years , but I previously determined that $39.72 was definitely not the right price. Now that they're cheaper, shares may now be at an attractive price, so I thought I'd review the name again. I'll determine whether or not it makes sense to buy based on the financial history here, and the valuation.
It's that time again, ladies and gentlemen. It's the time where I do my best to save you as much time as possible by giving you the "gist" of my thinking in this "thesis statement" paragraph. I offer this up to those people who want a little bit more than they get from the title and the bullet points above, but, perhaps understandably, want far less of my writing than they'd be exposed to in an entire article. You're welcome. I think investors would be wise to continue to avoid this stock at the moment. The financial results over the past nine months have been lackluster at best. If trends in the capital structure persist, the dividend growth we've seen must slow. Additionally, I don't think investors are seeking "returns." Investors are seeking "risk adjusted" returns, and in that context, it makes no sense to me to buy this stock when its dividend yield is about 200 basis points lower than the risk free rate. Put another way, why would you choose to get paid less for taking on more risk? Given the above, I must continue to recommend that investors avoid this name.
Financial Snapshot
There's no way to sugarcoat it, so I'm just going to come out with it. I think the latest financial results have been bad. Relative to the same time last year, revenue declined by about 3%, but net income absolutely collapsed, down 149% when compared to the same period last year. It's not like the previous year was some extraordinary outlier either, given that the same trend appears when we compare the latest with the same period in 2019. Compared to the same period in 2019, revenue today is about 14% higher, but net income is about 148%, or $156 million lower. In fairness, the company managed to keep some of the expenses in line. Specifically, cost of sales, and operating and administrative expenses were up by only 0.9% and down by 1% respectively. The chief culprit was the $99.8 million goodwill impairment the company took, but even if we added back that charge, net income would still be about $60 million lower than it was last year. Finally, for those who are willing to give companies a pass on goodwill drawdowns and don't like accruals very much, I'd point out that cash from operations was off by about 66% or $105 million from the year ago period.
But wait, there's more. The capital structure continues to deteriorate, with long term debt higher by about 3% when compared to last year, and fully 49% higher when compared to 2019. Perhaps this is why interest expenses have increased by about $12.5 million, or 85% from this time last year. This is troublesome in my estimation, as debt and interest payments will eventually crowd out dividend payments. That adds to the risk here in my view. That wouldn't disqualify the investment, but I would insist on only buying at a very reasonable price.
The Stock
As my regular readers know, my insistence on buying stocks that are attractively priced has cost me some profitable trades over the years. In response to this criticism, I'd point out that I'm of the view that it's better to miss out on some gains than lose capital, just because of the pernicious math around losses. For instance, if you lose 50% in year one, you need to make 100% in year two just to get back to breakeven. So, capital preservation is always key for me.
In addition to being a bit of an "overcautious wimp" as I was once called, my regulars also know that I consider the "business" and the "stock" to be quite different things. Every business buys a number of inputs and turns them into a final product or service, like richly priced textbooks, for instance. 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, future margins, and so on. The stock also moves around because it gets taken along for the ride when the crowd changes its views about "the market" in general. A reasonable sounding, if counterfactual, argument can be made to suggest that Wiley's stock would have done far worse since I last reviewed the name if the S&P 500 hadn't risen since then. It's impossible to prove this point definitively, but it's worth considering. In any case, the stock is affected by a host of variables that may be only peripherally related to the health of the business, and that can be frustrating.
This stock price volatility driven by all these factors is troublesome, but it's a potential source of profit because these price movements have the potential to create a disconnect between market expectations and subsequent reality. To be more specific, in my view the only way to generate profits trading stocks is 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. Cheap shares are insulated from the buffeting that more expensive shares are hit by.
As my regulars know, I measure the relative cheapness of a stock in a few ways, ranging from the simple to the more complex. 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. In case you don't have your copy of "Doyle's Almanac of 2022 Trades" in front of you, I recommended we continue to avoid this name when the shares were trading at a price to free cash flow of 10.10 times, and when the shares sported a dividend yield of 2.64%. Fast forward a few months, and the shares are now about 72% more expensive, but the dividend yield is about 4.5% higher at 2.75%, per the following:
I think it's worth noting that investors can receive just under 200 basis points more from a risk- free investment at the moment.
One more thing my regulars know is that I want to try to understand what the crowd is currently "assuming" about the future of a given company, and in order to do this, I rely on the work of Professor Stephen Penman and his book "Accounting for Value." 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 this formula. In case you find Penman's writing a bit dense, you might want to try "Expectations Investing" by Mauboussin and Rappaport. These two have also introduced the idea of using the stock price itself as a source of information, and then infer what the market is currently "expecting" about the future.
Anyway, applying this approach to John Wiley & Sons at the moment suggests that the market is assuming that this company will grow profits at a rate of about 1% from current levels. While I consider this to be a nicely pessimistic forecast, I can't get past the relative spread between the risk free rate and the dividend yield here.
In my view, investing is an inherently relativistic process. When you buy "X", you are, by definition, eschewing a series of "Ys." In my view, investors do best when they choose the best risk adjusted "X" available to them. Given that, I can't recommend buying John Wiley & Sons at current levels because the investor would be taking on more risk than they would with a Treasury, and would receive ~200 basis points less for their trouble. This makes little sense to me, and so I must continue to advise people to eschew these shares.
For further details see:
John Wiley & Sons: Taking On More Risk, Being Paid Less