Motley Fool Stock Advisor co-analyst Tom Gardner has said more than once that some of his worst investing decisions have been to cease investing too soon. To, in a word, "sell."
Sometimes, he's abandoned ship at a loss, as when he sold out of double-(percentage)-digit losers Hypercom (NYSE:HYC), Trex (NYSE:TWP), or Possis Medical (NASDAQ:POSS). Other times, he's gotten acrophobia from the rapid (and apparently unjustifiably so) rise of his winners -- Whole Foods (NASDAQ:WFMI) or Sanderson Farms (NASDAQ:SAFM) being perfect examples. However, when Tom recommended selling out of big screen video display-maker Daktronics (NASDAQ:DAKT) in June, it was for neither of these reasons.
The company was no dog -- on the contrary, after rising more than 18% over the year and a half since it joined the Stock Advisor portfolio, its stock was a certified market-beater. But growth was slowing and margins were being eroded as the company fought a winning, but Pyrrhic, battle for market share against competitors such as BARCO and BillBoard Video. In August, we saw the company continuing the same trends that convinced Tom it was destined for no better than market-average 10% gains over the next few years. At 10% a year, any investor can get by investing in an S&P 500-tracking mutual fund. Stock Advisor subscribers pay us to do better than that, and with Daktronics unlikely to live up to our previous hopes for the company, it had to go.
Judging from the market's reaction to Daktronics' fiscal Q2 2006 results, reported last week, it might appear that Tom made a mistake in ditching Daktronics. But I disagree. While the company's news had its bright spots, overall, I see it as continuing the same trend we saw reported in August. Backlog was again up considerably, to $81 million versus $50 million this time last year. But to win all those orders, the company had to sacrifice margins and profits growth once more. Despite growing sales 27% year over year, earnings were flat at $5.2 million. As a result, the company's margins to date look as follows:
|
Margins |
Fiscal H1 2005 |
Fiscal H1 2006 |
|---|---|---|
|
Gross |
34% |
30% |
|
Operating |
13% |
10% |
|
Net |
9% |
7% |
Moreover, to keep up with all of its costly new business, Daktronics will spend $20 million on capital improvements this year. Just the $7.9 million spent on capex in H1 2006 has sufficed to drive free cash flow down to negative $1.7 million. With another $12 million or so remaining to be spent in H2, I suspect the company will remain free cash flow-negative throughout the rest of the year.
In sum, accounting profits are stagnant. Free cash flow is declining. Yes, all in all, I suspect selling Daktronics was the right call.
Making right calls is a habit at Motley Fool Stock Advisor -- one that has helped our portfolio achieve 61% returns for subscribers over the past three years, against a 19% return for the S&P 500. Want to know what else Tom's selling -- or more importantly, what he's buying? Take a 30-day free trial of the newsletter, and we'll show you the whole portfolio, complete with the reasoning behind every one of Tom's buy and sell decisions. Click here to see it now.
Fool contributor Rich Smith holds no position in any company mentioned in this article.
