Investors in Natus Medical (NASDAQ:BABY) stock awoke to a shock this morning: Their stock has just been initiated with a rating of "strong sell."
Reacting immediately to the rating, Natus Medical stock sold off by more than 7% in early Friday trading, but what's curious is investors appear to have forgotten to ask: Exactly who is it that's panning their stock? And is there really a reason to panic? Couldn't it be that someone is tossing BABY out with the bathwater?
Here are three things we think you should know before deciding.
1. Who's to blame?
Let's start with who's to blame for today's sell-off. That would be Off Wall Street, a little known research shop that focuses on short-selling sizable stocks.
Here at Motley Fool CAPS, we follow the ratings and records of more than 200 of Wall Street's best and brightest analysts -- but we haven't had an opportunity to look at Off Wall Street before. Perhaps that's because this agency tends to keep to itself, and publishes only a handful of new recommendations annually.
According to its own website, Off Wall Street focuses on selling stocks, offering up "2x as many new 'sell' recommendations as 'buy' recommendations" annually, and focusing its efforts in the "Technology, Health, Financials, Energy, Industrials, and Consumer" industries. The company claims an "extraordinary track record" of being "right" on about 80% of its recommendations, and says it's beaten the S&P 500's returns by better than 5% in each of the past four years -- and by better than 10% in five years out of the past 12. (Our CAPS data cannot verify these claims, however.)
2. What they said
We haven't been able to obtain a full write-up of Off Wall Street's analysis of Natus Medical stock yet, but here's a quick summary from StreetInsider.com. According to the ratings aggregator, competitors are taking market share away from Natus (stealing candy from a BABY?), hurting its core business. The agency also believes that the Venezuelan medical system is going to stiff Natus on a $60 million bill, subtracting all the money from the company's revenue stream. (Natus management is inclined to agree on this downbeat assessment.)
Additionally, fans of the stock focus on Natus' long-standing strategy of mergers and acquisitions to grow its revenue stream, rolling up the fragmented industry for pre- and post-birth medical services and growing its own profits along the way. But Off Wall Street believes that hopes for Natus' growth are "overoptimistic," and the stock will fall short.
3. Is Off Wall Street off-base?
How seriously should Natus Medical investors take these concerns raised by Off Wall Street?
Well, let's see here. From 2011 to 2015, Natus Medical managed to grow its annual sales by 61%, indicating that its strategy of growing organically, and adding inorganic growth through acquisitions, had been working quite well. In 2016, however, this growth hit a snag. According to data from S&P Global Market Intelligence, Natus' trailing revenue of $374 million is actually slightly below last year's total of $376 million, which implies that when all's said and done, this year could be a losing year for Natus, revenue-wise.
Profits-wise, earnings are up slightly in comparison to last year ($41 million earned over the past 12 months, versus $38 million earned in all of 2015). That said, the company is trending toward perhaps high-single-digit earnings growth this year -- a far cry from analysts' prediction of 18.5% average long-term earnings growth for Natus over the next five years. This suggests that Off Wall Street may be right: Short-term results suggest that earnings expectations could be "overoptimistic."
The most important thing: Valuation
Of course, Natus' troubles this year have been on pretty public display, and they've had an effect on the stock already. Since 2016 began, Natus stock has shed roughly $10 of its share price, and fallen by about 23% in value. Off Wall Street thinks the stock hasn't finished falling, however, and predicts Natus shares will hit $24.75 within a year, falling another $10.
But with Natus stock down so much already, can it really fall further? Consider that right now, even after its steep decline, Natus Medical stock costs nearly 29 times trailing earnings. At first glance, that seems a pretty high price to pay for 18.5% growth. On the other hand, though, Natus has done a really good job of producing cash from its business. Regardless of what the GAAP numbers say, actual free cash flow at the company has exceeded $67 million over the course of the past 12 months. And valued on these cash profits, Natus is selling for only 17 times free cash flow -- which seems a fine price to pay for 18.5% growth.
Additionally, Natus sports a spotless balance sheet featuring more than $100 million in cash, and not a lick of long-term debt. Hmm.
I don't mean to discount Off Wall Street's concerns out of hand. But it seems to me that given the cash Natus is throwing off, the expectations for future growth, and the rock-solid balance sheet, the stock is actually in pretty good shape. If Off Wall Street is right about the growth rate being "overoptimistic," of course, all bets are off, and Natus could well be more expensive than it looks. But if the earnings estimates are anywhere close to right, it seems to me that Natus Medical remains a fine stock to buy today.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he currently ranks No. 345 out of more than 75,000 rated members.
The Motley Fool owns shares of and recommends Natus Medical. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.