Picture this: You've just found a stock that looks like it's a massive bargain on the basis of its valuation ratios. In the recent year, the company has grown, and there's no obvious red flags when it comes to debt, profitability, or leadership. You buy the stock only to see it go down over the next year. You've just fallen for a value trap.
Enter Organogenesis, (ORGO 1.82%) a wound-care company with a valuation that's priced for the shelves of a discount wholesaler. Is its valuation too good to be true, or is this stock a lucrative purchase for enterprising value investors? Let's look at the data and figure it out.
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What's valuable about this business?
Before we address the issue of whether this stock is a value trap, it's important to understand a few basic facts about the company.
Organogenesis has a handful of advanced wound-care and sports-medicine products on the market, treating a diverse range of acute wounds as well as chronic conditions like diabetic foot ulcers. Its dressings help to protect wounds from infection while also supporting the healing process, so it's safe to say that there will be a perpetual level of demand for them from healthcare systems.
Though the annual number of wounds requiring advanced care products is (hopefully) unlikely to increase, there's still plenty of room for growth in the market. As of 2021, only 5% of the eligible wounds in the U.S. were treated with an advanced dressing similar to what the company provides. Moving forward, Organogenesis plans to enter the burn-care market with its biosynthetic wound-matrix solutions like FortiShield and TransCyte, both of which should drive growth.
Speaking of growth, there's a lot to like about this company in terms of its recent performance. Organogenesis is firmly profitable, growing its margins over time, and its quarterly revenue has grown by 125% in the last three years, reaching $128.5 million in the most recent quarter. From 2016 to 2020, its revenue steadily grew with a compound annual growth rate (CAGR) of around 25%, which is quite good.
To cap it off, in the past 12 months, its quarterly net income has exploded by 420%, hitting $51.7 million in the fourth quarter of last year. But it might be hard to find more growth in 2022 and beyond. And that's where the prospects of this stock being a value trap come into the picture.
Gloomy projections and low valuations go hand-in-hand
Valuations tell investors what other investors are pricing into a company's future performance. Higher valuations imply expectations of faster growth, whereas depressed valuations signal anticipated trouble ahead. Of course, stocks can sometimes be priced at a bargain when the market's impressions are overly pessimistic. Sometimes, however, the market is right on the money.
In the case of Organogenesis, its price-to-sales (P/S) multiple is nearly 2.1, whereas its price-to-earnings (P/E) multiple is around 14.9. In contrast, the pharmaceutical industry's average P/S is 4.6 and its average P/E is around 30. Both of those metrics suggest that this stock is steeply undervalued relative to its peers. By definition, those are the first two pieces of evidence suggesting that there's a value trap as a value trap is only possible if there's an argument for a stock being undervalued.
Now, we'll get to the "trap." According to management's estimates for 2022, the company's net income for the year could be anywhere between $56.5 million and $71.5 million. Even the high value of that range implies significant shrinkage from 2021's net earnings of $94.9 million. There's a similar issue with the company's net revenue, which is only expected to increase by as much as 10% this year.
In short, management is open about the fact that 2022 won't be a bumper crop year like 2021 was. And that means the stock's cheap valuation is warranted and that there's a value trap for less discerning investors, at least for now.
Therefore, investors who buy Organogenesis stock today are likely to be disappointed if they're expecting rapid growth to continue -- and it's even possible that the stock will continue to go down this year. So, steer clear.
