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JDA Software (NASDAQ:JDAS) is a small player in the enterprise software solutions business and it competes with industry giants Oracle (NYSE:ORCL) and SAP (NYSE:SAP). Smaller players like JDAS are a dying breed in this industry. In addition, JDA Software is one of November’s Most Dan­ger­ous Stocks. And like all of our Most Dan­ger­ous Stocks the company has (1) mis­lead­ing earn­ings - account­ing prof­its are pos­i­tive and ris­ing while true, eco­nomic prof­its are neg­a­tive and falling and (2) high val­u­a­tion - very high expec­ta­tions embed­ded in the cur­rent valuation. JDAS gets our “very dangerous” rating.

Below are the specific red flags my research reveals:

  1. Mis­lead­ing earn­ings: JDAS reported a $14.6 million increase in GAAP earn­ings while our model shows eco­nomic earn­ings declined by $12.9 million (a dif­fer­ence of $27.5 million or 155% of reported net income).
  2. Very dan­ger­ous val­u­a­tion: Stock price of $27 implies JDAS must grow its NOPAT at over 20% com­pounded annu­ally for 10 years. A 10-year growth appre­ci­a­tion period with a 20%-plus com­pound­ing growth rate sets expectations for future cash flow performance quite high.
  3. JDAS competes with industry giants Oracle and SAP, whose businesses are growing stronger while JDAS appears to be weakening. I doubt a comeback is in the cards for JDAS.
  4. Free Cash Flow was -$203 million or -15% of the company’s enterprise value last year.
  5. Asset write-offs of $21 million or 3% of net assets – this means that management has written off at least $0.03 of assets for every $1 on the current balance sheet. Writing off assets is the opposite of creating shareholder value as it reflects management’s inability to derive any profits for the investments it makes with shareholder funds.
  6. Off-balance sheet debt of $40 million or 6% of net assets.
  7. Outstanding stock option liability of $13 million or 1% of current market value.

Over­all, the risk/reward of invest­ing in JDAS stock looks “very dan­ger­ous” to me. There is a lot of down­side risk given the mis­lead­ing earn­ings and red flags while there is lit­tle upside reward given the already-rich expec­ta­tions embed­ded in the stock price.

Our report on JDAS has detailed appendices for you to see how we perform all calculations. The primary cause of the dif­fer­ence between eco­nomic ver­sus account­ing earn­ings is that JDAS’s NOPAT rose much slower than its invested cap­i­tal.

In a business where investors make money by buying stocks with low expectations relative to their future potential, JDAS fits the pro­file of a great stock to short or sell.

Disclosure: No positions.

Source: Why JDA Software Cannot Compete With Industry Giants