A. O. Smith has followed the market’s trajectory closely, rising in tandem with the S&P 500 over the past six months. The stock has climbed by 9.8% to $72.38 per share while the index has gained 10.3%.

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

Why Is A. O. Smith Not Exciting?

We're sitting this one out for now. Here are three reasons you should be careful with AOS and a stock we'd rather own.

1. Core Business Falling Behind as Demand Plateaus

We can better understand HVAC and Water Systems companies by analyzing their organic revenue. This metric gives visibility into A. O. Smith’s core business because it excludes one-time events such as mergers, acquisitions, and divestitures along with foreign currency fluctuations - non-fundamental factors that can manipulate the income statement.

Over the last two years, A. O. Smith failed to grow its organic revenue. This performance was underwhelming and implies it may need to improve its products, pricing, or go-to-market strategy. It also suggests A. O. Smith might have to lean into acquisitions to accelerate growth, which isn’t ideal because M&A can be expensive and risky (integrations often disrupt focus).

2. Recent EPS Growth Below Our Standards

Although long-term earnings trends give us the big picture, we like to analyze EPS over a shorter period to see if we are missing a change in the business.

A. O. Smith’s weak 2.7% annual EPS growth over the last two years aligns with its revenue trend. This tells us it maintained its per-share profitability as it expanded.

3. New Investments Fail to Bear Fruit as ROIC Declines

ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. On average, A. O. Smith’s ROIC decreased by 3 percentage points annually over the last few years. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.

Final Judgment

A. O. Smith isn’t a terrible business, but it doesn’t pass our bar. That said, the stock currently trades at 18.3× forward P/E (or $72.38 per share). Investors with a higher risk tolerance might like the company, but we think the potential downside is too great. We're pretty confident there are more exciting stocks to buy at the moment. Let us point you toward the most entrenched endpoint security platform on the market.

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