The past six months have been a windfall for Funko’s shareholders. The company’s stock price has jumped 44.3%, hitting $13.39 per share. This performance may have investors wondering how to approach the situation.

We’re glad investors have benefited from the price increase, but we don't have much confidence in Funko. Here are three reasons why we avoid FNKO and a stock we'd rather own.

Why Do We Think Funko Will Underperform?

Boasting partnerships with media franchises like Marvel and One Piece, Funko (NASDAQ: FNKO) is a company specializing in creating and distributing licensed pop culture collectibles.

1. Long-Term Revenue Growth Disappoints

A company’s long-term sales performance can indicate its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Unfortunately, Funko’s 5.1% annualized revenue growth over the last five years was sluggish. This fell short of our benchmark for the consumer discretionary sector.

2. EPS Trending Down

Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.

Sadly for Funko, its EPS declined by 43% annually over the last five years while its revenue grew by 5.1%. 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 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, Funko’s ROIC has decreased significantly. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.

Final Judgment

Funko falls short of our quality standards. After the recent rally, the stock trades at 54.1× forward price-to-earnings (or $13.39 per share). At this valuation, there’s a lot of good news priced in - you can find better investment opportunities elsewhere. We’d suggest looking at Costco, one of Charlie Munger’s all-time favorite businesses.

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