When I look for new investments, I'm usually looking for stocks that I think will rapidly expand for the next few years. For me, that means looking for big revenue gains, steadily increasing financial strength, and great business models. But on the stock market, I often find more of what I'm not looking for.
It's obvious that declining revenue, debt, and antiquated or otherwise untimely business models can cause a company to crumble over time. There's no law of the universe that says struggling companies stay struggling forever, but you don't need to take any chances when there are plenty of better opportunities for growth. So, it's probably best to join me in avoiding a purchase of either of the two stocks I'll discuss today.
1. U.S. Physical Therapy
U.S. Physical Therapy (USPH 0.71%) isn't a bad company, and it has an important role to play in the healthcare system: It provides outpatient physical therapy for people recovering from injuries and medical interventions. But that doesn't mean it's a good stock to buy in 2021, in which in-person businesses are still struggling to deal with the pandemic's economic fallout.
The company's profit margin is thin at 7.12%, and its quarterly revenues are contracting by 7.4% year over year. Even if its revenue starts to grow again as the pandemic subsides, it's hard to envision demand for physical therapy really exploding. Plus, it might be on the hook for new overhead costs pertaining to making its facilities safer in light of the risk of contagion moving forward. So, it's not a great choice for investors seeking growth, nor is its profit margin wide enough to protect it from any more unexpected trouble.
U.S. Physical Therapy may also have financial trouble brewing. Its current ratio is 0.89, which means that its liquid assets are less than its liabilities due within one year. Worse yet, the current ratio has decayed steadily over the last five years, falling from remarkably healthy levels to its present value. That means the company's financial strength could be weakening over time, which tells me that it'll be hard for management to achieve the kind of growth that I'm looking for.
To top it off, this stock is too expensive. The trailing price to earnings (P/E) ratio is around 56, which is higher than the healthcare facility industry's average of 44.6. If you bought this stock, you'd be getting a worse-than-average deal, even before taking the other things I've mentioned into account.
2. Teva Pharmaceutical Industries
The Israeli generic medication manufacturer Teva Pharmaceutical Industries (TEVA -0.35%) is another stock that's simultaneously highly overpriced and reporting shrinking quarterly revenue. With a trailing P/E ratio of 872, the market is practically screaming that this stock's intrinsic value is lower -- I plan on listening, and avoiding a purchase accordingly.
Teva was also firmly unprofitable over the last two years, and heavily indebted. While it won't have trouble meeting its short-term debt obligations, its total debt of $26.09 billion looms large against its trailing levered free cash flow of $2.59 billion and $1.83 billion in cash. Manufacturing drugs is a capital-intensive business, so this pattern broadly makes sense: It borrowed money to buy new equipment, but now it can't run the equipment and produce drugs in a way that makes more money than it costs.
The problem is that demand for generic drugs may be more like a slow burn compared to the wildfire of patented ones. Patented drugs can be highly profitable for years, especially because the patent exclusivity guarantees that competitors can't copy the product and undercut the price. Generics are in the opposite situation: Anyone can produce them, so winning at price competition is the only way to make money. With fierce price competition, margins are slim by default. And, while some of Teva's drugs, like amoxicillin, are absolutely critical to human life and healthcare systems, they aren't hot sellers, and there isn't any reason to expect demand to increase anytime soon.
The market has already noticed that the company has been struggling. The stock has lost nearly 80% of its value over the last five years, and there's no indication that a rally is on the horizon.
Keep an arm's length away
Both of these companies are facing tough issues that can't be solved overnight, because their problems stem from their core business models. Neither has a secure future of revenue growth to look forward to. While actions by management can always turn their fortunes around, both stocks fail to even provide attractive valuations for investors. Thus, I'll be keeping a good distance from both, at least until their prices fall considerably.
This article represents the opinion of the writer(s), who may disagree with the "official" recommendation position of a Motley Fool premium advisory service. We're motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.