The Honest Company’s stock price has taken a beating over the past six months, shedding 23.9% of its value and falling to $3.80 per share. This might have investors contemplating their next move.

Is there a buying opportunity in The Honest Company, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.

Why Do We Think The Honest Company Will Underperform?

Despite the more favorable entry price, we're cautious about The Honest Company. Here are three reasons why HNST doesn't excite us and a stock we'd rather own.

1. Fewer Distribution Channels Limit its Ceiling

With $389.8 million in revenue over the past 12 months, The Honest Company is a small consumer staples company, which sometimes brings disadvantages compared to larger competitors benefiting from economies of scale and negotiating leverage with retailers. On the bright side, it can grow faster because it has a longer list of untapped store chains to sell into.

2. 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, The Honest Company’s margin dropped by 6.6 percentage points over the last year. Almost any movement in the wrong direction is undesirable because of its already low cash conversion. If the trend continues, it could signal it’s becoming a more capital-intensive business. The Honest Company’s free cash flow margin for the trailing 12 months was negative 1.5%.

3. Previous Growth Initiatives Have Lost Money

Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).

The Honest Company’s five-year average ROIC was negative 28.7%, meaning management lost money while trying to expand the business. Its returns were among the worst in the consumer staples sector.

Final Judgment

We see the value of companies helping consumers, but in the case of The Honest Company, we’re out. Following the recent decline, the stock trades at 14.4× forward EV-to-EBITDA (or $3.80 per share). This valuation tells us a lot of optimism is priced in - we think other companies feature superior fundamentals at the moment. We’d recommend looking at the Amazon and PayPal of Latin America.

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