Donaldson’s 26.4% return over the past six months has outpaced the S&P 500 by 5.4%, and its stock price has climbed to $84.25 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Donaldson, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free for active Edge members.
Why Is Donaldson Not Exciting?
We’re glad investors have benefited from the price increase, but we're swiping left on Donaldson for now. Here are three reasons why DCI doesn't excite us and a stock we'd rather own.
1. Weak Constant Currency Growth Points to Soft Demand
Investors interested in Gas and Liquid Handling companies should track constant currency revenue in addition to reported revenue. This metric excludes currency movements, which are outside of Donaldson’s control and are not indicative of underlying demand.
Over the last two years, Donaldson’s constant currency revenue averaged 3.6% year-on-year growth. This performance was underwhelming and suggests it might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability. 
2. Projected Revenue Growth Is Slim
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.
Over the next 12 months, sell-side analysts expect Donaldson’s revenue to rise by 3.2%, close to its 7.4% annualized growth for the past five years. This projection doesn't excite us and indicates its newer products and services will not accelerate its top-line performance yet.
3. Free Cash Flow Margin Dropping
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Donaldson’s margin dropped by 2.8 percentage points over the last five years. If its declines continue, it could signal increasing investment needs and capital intensity. Donaldson’s free cash flow margin for the trailing 12 months was 9.3%.
Final Judgment
Donaldson isn’t a terrible business, but it doesn’t pass our quality test. With its shares beating the market recently, the stock trades at 21× forward P/E (or $84.25 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We're pretty confident there are more exciting stocks to buy at the moment. We’d suggest looking at a dominant Aerospace business that has perfected its M&A strategy.
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