To weed out the riskiest stocks, Société Générale‘s analysts have put together an “expensive stocks with poor earnings quality” screen.
This screen has two main parts. The first is an earnings quality assessment, which looks at ten different earnings quality factors.
These factors are based on the ten most common methods of earnings manipulation, including factors like inventory levels, cash generation and rising levels of receivables.
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The second part of the screen is a basic valuation assessment. Companies with the highest valuations but lowest earnings quality make it on to Société Générale’s naughty list.
All stocks in the FTSE World Developed and FTSE 350 indexes are included in the screen. Here are the UK companies that currently qualify.
Look out below!
Just Eat (LSE: JE) leads the list of expensive stocks with poor quality earnings and it’s easy to see why.
The company currently trades at an eye-watering forward P/E of 74, which looks expensive, even after factoring in projected earnings growth of 40% this year. What’s more, Just Eat looks expensive on several other metrics, including P/B, price-to-sales, and price-to-free-cash-flow.
In fact, Just Eat is one of the most expensive companies in the technology sector, a sector that’s renowned for high valuations.
Poor earnings quality
Cable and Wireless (LSE: CWC) is anther stock investors should stay away from.
Cable is currently trading at a forward P/E of 25.6, a significant premium to the telecoms sector average of 14.7.
Moreover, Cable’s earnings history over the past few years leaves much to be desired. The company’s net profit has fallen 17% since 2010, and operating cash flow has declined by 42%.
What’s even more concerning is the fact that since 2010, Cable’s net debt has tripled. Return on capital employed has collapsed from 19% to 1% during the same period.
Resource dependant
As the world’s leading silver producer, Fresnillo’s (LSE: FRES) outlook is tied to the silver price. Unfortunately, as the price of precious metals has fallen, Fresnillo’s income has also collapsed.
Since 2011 Fresnillo’s net income has declined by 88%. The company’s operating cash flow has followed suit and for the past two years, Fresnillo’s capital spending has exceeded cash generated from operations.
As a result, Fresnillo has been forced to borrow heavily. Since 2011 Fresnillo has gone from reporting a solid cash balance of $685m to net debt of $347m.
Overall, Fresnillo is struggling, and the company’s forward P/E of 30.6 hardly seems appropriate.
High dividend risk
Alongside the expensive stocks with poor earnings quality screen, Société Générale also publishes a monthly “high dividend risk“. This screen seeks to weed out those companies that are likely to cut their dividend payouts in the near future.
EVRAZ (LSE: EVR) is just one of the five UK firms that made it onto the high dividend risk screen this month. Analysts expect the company to offer investors a dividend of 6.9p per share this year, a yield of 4.5%.
According to estimates, this payout will be covered three-and-a-half times by earnings per share. However, with net gearing of 284%, EVRAZ should be retaining cash to pay down debt, not distributing valuable profits to investors.
So, there is a chance that the steel maker could be forced to slash its payout to preserve cash in the future.
