What a brutal six months it’s been for Watsco. The stock has dropped 29.2% and now trades at $364.49, rattling many shareholders. This was partly due to its softer quarterly results and might have investors contemplating their next move.

Is there a buying opportunity in Watsco, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free for active Edge members.

Why Is Watsco Not Exciting?

Even with the cheaper entry price, we're swiping left on Watsco for now. Here are three reasons we avoid WSO and a stock we'd rather own.

1. Flat Same-Store Sales Indicate Weak Demand

Investors interested in Infrastructure Distributors companies should track same-store sales in addition to reported revenue. This metric measures the change in sales at brick-and-mortar locations that have existed for at least a year, giving visibility into Watsco’s underlying demand characteristics.

Over the last two years, Watsco failed to grow its same-store sales. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Watsco might have to change its strategy and pricing, which can disrupt operations.

2. EPS Took a Dip Over the Last Two Years

Although long-term earnings trends give us the big picture, we like to analyze EPS over a shorter period to see if we are missing a change in the business.

Sadly for Watsco, its EPS declined by 2.2% annually over the last two years while its revenue grew by 2.3%. 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).

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Watsco’s ROIC has decreased over the last few years. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.

Final Judgment

Watsco isn’t a terrible business, but it isn’t one of our picks. After the recent drawdown, the stock trades at 26.3× forward P/E (or $364.49 per share). Beauty is in the eye of the beholder, but our analysis shows the upside isn’t great compared to the potential downside. We're pretty confident there are more exciting stocks to buy at the moment. We’d recommend looking at an all-weather company that owns household favorite Taco Bell.

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