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The Market Hated Financial Results for These 4 Stocks. Are Investors Getting It All Wrong?

Motley Fool - Thu Nov 9, 2023

Four times annually, investors are inundated with financial news from public companies. Public companies tend to report their numbers on a quarterly basis, and the majority report at about the same time. This time is affectionately called earnings season.

Hundreds of companies have already reported this earnings season, including shoe company Crocs(NASDAQ: CROX), home-improvement retailer Floor & Decor(NYSE: FND), and enterprise-software companies Paycom Software(NYSE: PAYC) and Confluent(NASDAQ: CFLT). And the market hated the financial reports from all four of these companies.

Every situation is unique, and I believe investors are correct to react as they have for some of these. However, with one of these stocks in particular, I believe the market is getting it totally wrong.

Here's a brief overview of what the market hated with each stock, and which one it's getting wrong.

1. Crocs

Crocs is a well-known shoe brand. But after spending $2.5 billion in 2021 to acquire HeyDude, the company is now home to two brands.

On Nov. 2, Crocs reported financial results for the third quarter of 2023. Revenue of more than $1 billion was up over 6% year over year. And the company had an operating margin of 26%. What's wrong with that?

Well, the market focused on Crocs' HeyDude brand. Crocs gets revenue from two sources: direct-to-consumer sales from its own stores and e-commerce channels, and wholesale revenue by supplying retail partners. HeyDude's bigger revenue source is wholesale. And unfortunately, Q3 wholesale revenue for HeyDude dropped 19% year over year.

Seeing growth stall out for HeyDude this soon after acquiring it doesn't look good. This is a big reason Crocs stock sold off after the report.

2. Floor & Decor

Floor & Decor is a home-improvement retailer that's expanding quickly by opening new locations. It has 207 warehouse-style locations right now, but it hopes to have about 500 by around 2030.

Floor & Decor joined Crocs on Nov. 2 in reporting financial results. Investors who were paying attention already knew that 2023 has been tough for home-improvement retail. Floor & Decor's same-store sales are down this year after 14 consecutive years of growth. And same-store sales are down for other players in the space as well. However, things are dropping for the company more than anticipated.

In its Q3 2023, Floor & Decor's same-store sales fell by 9.3% compared to the prior-year period. And less sales volume per existing store makes operations less efficient and consequently reduces profitability.

Floor & Decor has still grown sales overall this year by opening new locations. But through the first three quarters of the year, its net income is down 8.8% from the comparable period of 2022. The market hates that.

3. Paycom Software

Paycom is a software company that helps businesses manage their workforces, largely with its payroll services. The company reported financial results for Q3 2023 on Oct. 31, and the stock subsequently dropped around 40%.

Paycom's business is either doing really poorly or really well, depending on one's perspective. Evidently, the perspective from investors is that it's doing really poorly.

According to Paycom's management, its newer self-serve product Beti is so good that its customers are making fewer mistakes and need help from Paycom less often -- and this hurts its revenue.

In Q3, Paycom's revenue was up 21.6% year over year, which is a lower growth rate than what investors are accustomed to. But growth rates are slowing because of Beti. In the upcoming fourth quarter, management expects revenue to be up less than 15%. And in 2024, it's forecasting just 10% to 12% growth.

PAYC Revenue (Quarterly YoY Growth) Chart

PAYC Revenue (Quarterly YoY Growth) data by YCharts

The market hates Paycom's sharply declining growth rate, and that's why the stock is down.

4. Confluent

Confluent is a real-time enterprise data infrastructure company. This earnings season, it reported Q3 2023 results on Nov. 1. Its problem was the same as Paycom's: The market doesn't like its swiftly deteriorating growth rate. The stock fell more than 40% in the aftermath.

In Q3, Confluent had revenue of $200 million, which was ahead of management's guidance and up 32% year over year. While that is a good growth rate for many businesses, it's a continuation of a multi-year slowdown. As the chart below shows, the stock price keeps dropping with the drop in the growth rate.

CFLT Chart

CFLT data by YCharts

In short, Confluent just reported its slowest ever top-line growth. Unfortunately, it plans to report even slower growth in the coming quarter. For Q4, management expects to generate revenue of $205 million at best, which would only be a 22% increase from Q4 2022.

Also problematic is Confluent's slowing growth for remaining performance obligations (RPO). As a subscription business, RPO gives investors insight into trends beneath the surface. In Q3, the company's RPO was only up 24% compared to 32% revenue growth. This lagging indicator suggests that its growth rate has more room to slow down.

Investors are getting one of these stocks all wrong

Shares of Crocs, Floor & Decor, Paycom, and Confluent all sold off after reporting financial results. If this created a timely opportunity for any of them, I believe the case is weakest for Confluent. The company is well-funded and still growing. But it still trades at a pricey 7 times its trailing sales, which doesn't look particularly attractive given how fast its growth is slowing.

Turning away from Confluent, Paycom and Floor & Decor are in the same boat, in my opinion: The businesses are fine for the long term, but both may experience some short-term pain.

For Floor & Decor (and other home-improvement retailers), there's evidence that the housing market is slowing and that it could get worse. That's historically slowed sales for these businesses. That said, Floor & Decor is still profitable and will keep expanding by opening new stores. Therefore, it will be in a good position to bounce back when the housing market improves.

Paycom is doing what's clearly best for customers. Providing software that's cheaper and easier is obviously the right choice if you want to keep your customers. That said, this does affect its business model, and it's unclear what the long-term implications will be.

This leaves Crocs as the clear winner here for me. But it's not only that I like Crocs stock better than the other three. It's more than that: I believe the market's reaction to Crocs' Q3 results was dead wrong.

I explained that the market didn't like declining wholesale revenue for Crocs' HeyDude brand. However, I believe the market is overlooking its 14.6% year-over-year growth for HeyDude's direct-to-consumer revenue. This could signal that consumer awareness for HeyDude continues to rise, which would be good for the long-term growth opportunity of that brand.

Here's the cherry on top: Crocs is still incredibly profitable, as evidenced by its Q3 operating margin of 26%. It had paused share repurchases to pay down its debt from its acquisition of HeyDude. But having repaid nearly $400 million year to date, it's resumed share repurchases with its hefty profits.

Crocs stock is down 24% from the start of 2023 and trades at just 7.6 times trailing earnings. Because of this, the company's share repurchases will stretch further and offer better return for long-term shareholders. The company doesn't need to blow the doors off when it comes to growth. It just needs to keep profits rolling (as it is) and continue systematically reducing its share count for this to be a big winner. And this is why I believe Crocs is a screaming buy today.

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Jon Quast has positions in Crocs and Floor & Decor. The Motley Fool has positions in and recommends Confluent and Paycom Software. The Motley Fool recommends Crocs. The Motley Fool has a disclosure policy.

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