Steel City Capital recently released its Q4 2020 Investor Letter, a copy of which you can download here. In 2020, the fund returned 10% net of fees, while the S&P 500 Index was up 16.3%. You should check out Steel City Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of 2021.
In the Q4 2020 Investor Letter, Steel City Capital highlighted a few stocks and WD-40 Company (NASDAQ:WDFC) is one of them. WD-40 Company (NASDAQ:WDFC) manufactures and markets multi-purpose lubricant products and heavy-duty hand cleaners. In the last three months, WD-40 Company (NASDAQ:WDFC) stock gained 20.6% and on January 20th it had a closing price of $282.84. Here is what Steel City Capital said:
“WD-40 Company (Short): WDFC is a household name and a phenomenal business. The company’s main product is a lubricant that silences squeaky door hinges, dissolves adhesives, and loosens up the rustiest of bike chains. Its easily identifiable blue and yellow can – as recognizable as a can of Coke – is found in homes and industrial settings around the world. WDFC is stunningly profitable, owing to its business model which primarily focuses on sales and marketing, leaving the more capital-intensive aspects of manufacturing and distribution to others. Last fiscal year, the company generated a return on equity of 34%, highlighting its exceptional profitability.
So why is the Partnership short what is so obviously an attractive and profitable business? My thesis is fairly simple: the market is capitalizing peak earnings at an all-time high multiple, and both factors will more likely than not unwind over the next several years. Earnings have gotten a boost on two fronts. First, crude oil is one of the company’s primary feedstocks. Its decline from ~$100/bbl in FY’14 to a range between $40-$60/bbl in recent years has allowed WDFC’s margins to expand by ~3.0%. Second, 2017’s tax reform brought the company’s normalized tax rate down by ~10%, providing an additional boost to earnings. If we enter a period of sustained inflation, oil prices will rise, turning what has been a helpful tailwind into a challenging headwind. Moreover, I can’t foresee any circumstances under which corporate tax rates will decline further from their current level.
The chart below illustrates WDFC’s forward P/E multiple. If you’re like me, you’ll probably do a double take, because at first glance, you might think this is a stock price chart. As it stands today, WDFC trades with a forward multiple of ~50x, which is its highest point in 10-years and more than 2 standard deviations above its long-term average of 28x. The current multiple equates to an earnings yield of ~2% for a company that should, at best, experience pedestrian earnings growth in the years to come (limited opportunities for margin expansion), and at worst, see earnings materially contract in the event its most important raw material increases in price. This is happening at a point in time when the 10-year Treasury yield has quietly moved higher, with potentially lots of room to go if the incoming administration gets its way on stimulus spending and/or the Fed gets its wish on inflation. All else equal, higher rates will drive the P/E multiple lower. A double whammy of lower earnings and a lower multiple would produce a painful surprise to WDFC shareholders. (Of course, many of these “owners” are indifferent to the high valuation of the stock: 21.5% of outstanding shares are held by index funds or ETFs. This indifference to valuation, no matter how extreme, is part of the explanation for WDFC’s exceptional valuation and again provides a window into the dynamic driving the broader market to all-time highs.)”
In Q3 2020, the number of bullish hedge fund positions on WD-40 Company (NASDAQ:WDFC) stock increased by about 13% from the previous quarter (see the chart here), so a number of other hedge fund managers believe in WDFC’s growth potential. Our calculations showed that WD-40 Company (NASDAQ:WDFC) isn’t ranked among the 30 most popular stocks among hedge funds.
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Video: Top 5 Stocks Among Hedge Funds
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Disclosure: None. This article is originally published at Insider Monkey.