Shareholders of CoStar would probably like to forget the past six months even happened. The stock dropped 28.5% and now trades at $32.29. This was partly due to its softer quarterly results and might have investors contemplating their next move.
Is now the time to buy CoStar, 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 CoStar Not Exciting?
Despite the more favorable entry price, we’re sitting this one out for now. Here are three reasons you should be careful with CSGP, plus one stock we’d rather own.
1. Shrinking Adjusted Operating Margin
Adjusted operating margin is one of the best measures of profitability because it tells us how much money a company takes home after subtracting all core expenses, like marketing and R&D. It also removes various one-time costs to paint a better picture of normalized profits.
Analyzing the trend in its profitability, CoStar’s adjusted operating margin decreased by 16.3 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. Its adjusted operating margin for the trailing 12 months was 15.5%.
2. Free Cash Flow Margin Dropping
Free cash flow isn’t a prominently featured metric in company financials and earnings releases, but we think it’s telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, CoStar’s margin dropped by 10.8 percentage points over the last five years. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. Almost any movement in the wrong direction is undesirable because of its relatively low cash conversion. If the longer-term trend returns, it could signal it’s in the middle of a big investment cycle. CoStar’s free cash flow margin for the trailing 12 months was 6.4%.
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).
Unfortunately, CoStar’s ROIC has decreased significantly over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
Final Judgment
CoStar isn’t a terrible business, but it doesn’t pass our bar. Following the recent decline, the stock trades at 20.2× forward P/E (or $32.29 per share). Investors with a higher risk tolerance might like the company, but we think the potential downside is too great. We’re pretty confident there are more exciting stocks to buy at the moment. Let us point you toward a dominant aerospace business that has perfected its M&A strategy.
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