- I think Echo Global Logistics had a spectacular year, the fourth quarter in particular. Earnings grew nicely, and the capital structure is much less risky.
- That said, we don't buy companies. We buy stocks, and the returns we make on those stocks is a function of the price we pay. Shares aren't cheap right now.
- I recommended selling puts in my previous article. I offer a (very self congratulatory) review of how those have gone.
It’s been a few months since I wrote a neutral piece about Echo Global Logistics Inc. (NASDAQ:ECHO), and in that time, the shares have risen about 5.6% against a gain of 2.5% for the S&P 500. The company has published full year results since, so I thought I’d look at the company again. To refresh your memories, dear readers, my earlier view could be summed up onomatopoeically as “meh.” I was turned off by the fact that net income had fallen in 2020 relative to 2019 in spite of an uptick in revenue. That, coupled with the fact that the shares were reasonably priced kept me from buying the stock. That said, I did write puts on the name, as I saw value here, just not at the then market price. I’ll determine whether I want to buy or not by looking at the financial history here, and by looking at the stock as a thing quite distinct from the underlying business. Also, those who know me best know that I love to brag whenever it’s appropriate and often when it’s inappropriate to do so. I offer that as a warning because I’ll be bragging incessantly when I write about the short puts here.
You’re a busy group, dear readers, and so I’ll jump right to the point in case you missed the title of this article, and skipped over the bullet points above. I was very pleasantly surprised by Echo Global’s financial performance in 2020, especially the final quarter. That said, we buy stocks, and there’s a negative relationship between price paid and subsequent returns. The great performance here is hardly a state secret, and the market price reflects that. For that reason, if history is any guide (it frequently is), now would be a relatively bad time to invest. I’d rather buy this stock when the news out of Echo Global was bad, and it’s all just too good at the moment. I must recommend avoiding these shares.
I’d suggest to you, dear readers, that the financial performance has been spectacular throughout 2020, and in the fourth quarter in particular. Revenue and net income in 2020 were 15%, and 6.5% higher relative to 2019. Revenue and net income in the fourth quarter alone picked up by 43%, and a whopping 227% relative to the first three quarters of last year. It was a very, very impressive performance in my estimation. In addition, the company retired fully 14% or $22.4 million of debt, so the capital structure is in even better shape. The reduction in debt has led to a 53% reduction in interest expense, which was $6.65 million lower in 2020 than in 2019.
It’s good to know that I can still be surprised, dear readers, and I was very pleasantly surprised by the financial performance here. In case it isn’t front of mind for some reason, in my earlier missive I went on about the fact that in the first nine months of 2020, revenue was up by net income was lower. Profitability rebounded in a very strong and surprising (to me) way. I have nothing negative to say about the performance, and I come from the school of thought that says, if you can’t say something negative, say nothing at all. For that reason, I’ll just sum up by stating that I’d be happy to own this company if the shares aren’t too optimistically priced.
Source: Company filings
It’s possible that a good company can be a terrible investment if you overpay for it. I often make this point by constructing strings of logic where I argue that a lower priced stock is definitionally less risky than a more expensive one. I’m not currently in the mood for such philosophizing, though, so I’ll just use Echo Global as a test case to demonstrate the negative relationship between price paid and returns earned. In order to do this, I’ll pick two dates completely at random that also happen to be rhetorically helpful for my argument.
If an investor bought in mid-September 2018, they’d be sitting on a loss of ~17% at the moment. Had they bought exactly one year later, they’d be sitting on a gain of about 24%. The narrative hadn’t changed much from one period to the next, but the returns were vastly different, depending only on the price paid. For my part, I’d rather have a gain of 24% than a loss of 17%, so I want to buy the stock when the valuation resembles the same level as it did in the former price.
My regular readers know that I measure cheapness in a host of ways, ranging from the simple to the more complex. On the simple side, I look at the ratio of price to some measure of economic value, like earnings, free cash flow, and the like. Ideally, I want to see a company trading at a discount relative to both the overall market and its own history. Please note that in September 2019 (i.e. a very good time to have bought), the shares were trading at a price to free cash of ~8 times. In September 2018 (i.e. a very bad time to have bought), the shares were trading at a price to free cash flow of ~ 25 times. With that context out of the way, please note that at the moment, the shares are trading closer to 2018 levels than 2019s.
In addition to looking at the simple relationship between price and value, I want to try to determine what the market is “thinking” at the moment. In order to do this, I rely on the work done by Professor Stephen Penman in his book “Accounting for Value.” In the book, Penman walks investors through how they can isolate the “g” (growth) variable in a fairly standard finance formula to work out what the world must be thinking about a given company’s future. Applying this methodology to Echo seems to suggest that the market is assuming a perpetual growth rate of ~8.5% here. I consider this to be a fairly optimistic forecast, and so I’m forced to stay away from the stock at current levels.
In my previous missive on this name, I was hesitant about the stock price as I am now, and I recommended investors sell puts in lieu of shares as a way to generate some kind of return. In particular, I recommended selling the June 2021 puts with a strike of $22.50 for $1.20. These are currently bid at $.75, and last traded hands at $1.05. The latter price is not much of a concern for me, as these aren’t particularly liquid puts. I like the fact that they have lost about 3 months of time value and are now 22.5% out of the money as opposed to being “only” 18% when I last wrote about this business.
If these expire worthless, I’ll be happy, obviously. If they are exercised, I’ll be happy. I like situations that result in a happy me no matter the outcome.
While I normally like to try to repeat success, I can’t do so in this case. Unfortunately, I can’t find any puts that are offering reasonable premia for reasonable strike prices, and so I can’t offer you another options trade, dear readers. If the shares fall in price, I’ll certainly write more, but it’s not possible at the moment.
I think this business has performed wonderfully over the past year in general, and the last quarter in particular. I can find nothing in the financials to criticize, which is rare for me. That said, I think the stock remains relatively richly priced. This shouldn’t come as a shock because it’s not like the story of Echo Global’s success is a secret. For my part, I’d rather buy these shares when the market is only willing to bid them at 8 times free cash flow, as that’s corresponded to great returns from that level. Unfortunately, the shares are trading at over twice that level at the moment, so I’m inclined to stay away. I’d rather forego a few dollars of future returns than risk capital at this point. I’m probably lucky that I sold the puts I did last December, and can’t find others to sell at the moment. For that reason, in my view, all any of us can do is sit and wait for shares to drop in price, and when they do, to buy aggressively.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Going to let my short puts ride.
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