Over the past six months, DNOW’s shares (currently trading at $12.71) have posted a disappointing 7.2% loss, well below the S&P 500’s 9% gain. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.

Is now the time to buy DNOW, or should you be careful about including it in your portfolio? Get the full stock story straight from our expert analysts, it’s free.

Why Is DNOW Not Exciting?

Even with the cheaper entry price, we’re cautious about DNOW. Here are three reasons we avoid DNOW, plus one stock we’d rather own.

1. Shrinking Operating Margin

Operating margin is an important measure of profitability as it shows the portion of revenue left after accounting for all core expenses — everything from the cost of goods sold to advertising and wages. It’s also useful for comparing profitability across companies with different levels of debt and tax rates because it excludes interest and taxes.

Analyzing the trend in its profitability, DNOW’s operating margin decreased by 6.9 percentage points over the last five years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. DNOW’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was negative 4.6%.

2. EPS Took a Dip Over the Last Two Years

While long-term earnings trends give us the big picture, we also track EPS over a shorter period because it can provide insight into an emerging theme or development for the business.

Sadly for DNOW, its EPS declined by 13.9% annually over the last two years while its revenue grew by 21.7%. This tells us the company became less profitable on a per-share basis as it expanded.

3. New Investments Fail to Bear Fruit as ROIC Declines

A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).

Over the last few years, DNOW’s ROIC has unfortunately decreased significantly. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.

Final Judgment

DNOW isn’t a terrible business, but it doesn’t pass our bar. After the recent drawdown, the stock trades at $12.71 per share (or a forward price-to-sales ratio of 0.5×). The market typically values companies like DNOW based on their anticipated profits for the next 12 months, but there aren’t enough published estimates to arrive at a reliable number. You should avoid this stock for now - better opportunities lie elsewhere. We’d suggest looking at a dominant aerospace business that has perfected its M&A strategy.

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