Over the past few decades, there has been a boom in demand for so-called “low volatility” stocks. These companies tend to be high-quality Consumer Staples, Heathlcare of Industrial names, like 3M Company or PepsiCo, Inc.
However, in most cases, the boom in demand for these names has not matched their growth. As a result, we’ve seen historical valuation correlations between peer companies and relative valuation metrics breaking down as investors clamour to buy these stocks without considering the underlying fundamentals of the business.
According to analysis from Voss Capital, in many instances, multiples for companies are two to three times higher than their 10 to 20year averages/means despite company-specific growth is often only a small fraction of what it was at previous peak multiples.
WD-40 is a prime example of this trend. From Voss Capital’s second-quarter letter to investors:
“WD-40 Co (WDFC) traded at an EV/Sales multiple of around 2x from January 2000 to July 2013. It was around that time that it saw a steady march higher due mostly to major multiple expansion up to 6x EV/sales and has had no mean reversion in multiple in the last few years despite no material inflection or improvement in sales growth, margins, or return on invested capital (ROIC). WDFC’s EV/EBITDA multiple stayed in a relatively tight range of 8x – 12x from 1992 to 2013 and it has subsequently tripled to 30x. On an earnings basis, WDFC now trades at 38x forward earnings estimates despite most of its underlying revenue being tied to cyclical industrial production and having only low-single-digit top line growth projected (3.7%).”
Voss speculates that one of the reasons behind this multiple expansion despite “no material improvement in fundamentals” is flows from passive funds. “Together BlackRock and Vanguard funds now own nearly 25% of WDFC shares and they have been steady buyers despite the tripling in WDFC’s valuation,” the letter goes on to note. In total, WD-40 is owned across 88 different ETFs and with a beta of only 0.25 continues to get “relentlessly bid up as part of the low vol stock bubble.”
What happens from here? It is impossible to tell. Voss points out that WD-40’s management has laid out some aspirational growth targets, but to meet these, the company will have to print record-breaking figures:
“WDFC management recently laid out their 2025 guidance. To meet their aspirational targets, they will need to achieve an 8% sales CAGR, which contrasts with their trailing sales CAGR of 2.8% from 2011 through 2018 (a period of uninterrupted economic growth with no US recession). Additionally, they will have to achieve record margins and expand them by another ~5% despite an EBITDA margin decline of 100 bps in the most recent quarter. Even if they pull off the Herculean task of sustainably tripling their growth rate this late into an economic cycle, the stock would still be priced at 14.6x their 2025 EBITDA target, which is six years out and 26% above the 35-year median trailing multiple.”
The question is, will the market continue to give the business the benefit of the doubt if it does not meet these targets? Only time will tell.