What a time it’s been for American Outdoor Brands. In the past six months alone, the company’s stock price has increased by a massive 62.9%, reaching $13.80 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.

Despite the momentum, we're cautious about American Outdoor Brands. Here are three reasons why AOUT doesn't excite us and a stock we'd rather own.

Why Do We Think American Outdoor Brands Will Underperform?

Spun off from Smith and Wesson in 2020, American Outdoor Brands (NASDAQ: AOUT) is an outdoor and recreational products company that offers firearms and firearm accessories.

1. Long-Term Revenue Growth Disappoints

Reviewing a company’s long-term sales performance reveals insights into its quality. Any business can have short-term success, but a top-tier one grows for years. Regrettably, American Outdoor Brands’s sales grew at a sluggish 4.7% compounded annual growth rate over the last five years. This was below our standard for the consumer discretionary sector.

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 typically prefer to invest in companies with high returns because it means they have viable business models, but the trend in a company’s ROIC is often what surprises the market and moves the stock price. Over the last few years, American Outdoor Brands’s ROIC has decreased. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.

3. High Debt Levels Increase Risk

Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.

American Outdoor Brands’s $33.98 million of debt exceeds the $14.22 million of cash on its balance sheet. Furthermore, its 11× net-debt-to-EBITDA ratio (based on its EBITDA of $1.80 million over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. American Outdoor Brands could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope American Outdoor Brands can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.

Final Judgment

American Outdoor Brands doesn’t pass our quality test. After the recent rally, the stock trades at 44.5× forward price-to-earnings (or $13.80 per share). This valuation tells us a lot of optimism is priced in - we think there are better investment opportunities out there. We’d suggest looking at Yum! Brands, an all-weather company that owns household favorite Taco Bell.

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