ADT has had an impressive run over the past six months. While the S&P 500 has been flat, the stock has returned 9.2% and now trades at $7.92. This was partly thanks to its solid quarterly results, and the performance may have investors wondering how to approach the situation.

Is there a buying opportunity in ADT, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.

We’re happy investors have made money, but we're cautious about ADT. Here are three reasons why ADT doesn't excite us and a stock we'd rather own.

Why Is ADT Not Exciting?

Founded in 1874 and headquartered in Boca Raton, Florida, ADT (NYSE: ADT) is a provider of security, automation, and smart home solutions, offering comprehensive services for home and business protection.

1. Decline in Customers Points to Weak Demand

Revenue growth can be broken down into changes in price and volume (for companies like ADT, our preferred volume metric is customers). While both are important, the latter is the most critical to analyze because prices have a ceiling.

ADT’s customers came in at 6.4 million in the latest quarter, and over the last two years, averaged 2.3% year-on-year declines. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests ADT might have to lower prices or invest in product improvements to grow, 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 ADT’s revenue to rise by 3.9%. Although this projection suggests its newer products and services will spur better top-line performance, it is still below average for the sector.

3. Previous Growth Initiatives Haven’t Impressed

Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? Enter ROIC, a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).

ADT historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 4.4%, lower than the typical cost of capital (how much it costs to raise money) for consumer discretionary companies.

Final Judgment

ADT isn’t a terrible business, but it doesn’t pass our bar. With its shares topping the market in recent months, the stock trades at 9.8× forward price-to-earnings (or $7.92 per share). While this valuation is optically cheap, the potential downside is big given its shaky fundamentals. We're pretty confident there are superior stocks to buy right now. We’d recommend looking at one of our all-time favorite software stocks.

Stocks We Like More Than ADT

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