What a fantastic six months it’s been for Purple. Shares of the company have skyrocketed 40.4%, hitting $0.94. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
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Why Do We Think Purple Will Underperform?
We’re glad investors have benefited from the price increase, but we don't have much confidence in Purple. Here are three reasons we avoid PRPL and a stock we'd rather own.
1. Revenue Spiraling Downwards
A company’s long-term sales performance is one signal of its overall quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years. Purple’s demand was weak over the last five years as its sales fell at a 2.9% annual rate. This wasn’t a great result and signals it’s a low quality business.
2. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative 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, Purple’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.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Purple burned through $26.51 million of cash over the last year, and its $220.4 million of debt exceeds the $34.25 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Purple’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Purple until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
We cheer for all companies serving everyday consumers, but in the case of Purple, we’ll be cheering from the sidelines. Following the recent surge, the stock trades at 11.1× forward EV-to-EBITDA (or $0.94 per share). This multiple tells us a lot of good news is priced in - you can find more timely opportunities elsewhere. We’d recommend looking at a safe-and-steady industrials business benefiting from an upgrade cycle.
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