Over the past six months, Transcat’s shares (currently trading at $87.50) have posted a disappointing 17.3% loss, well below the S&P 500’s 7.1% gain. This may have investors wondering how to approach the situation.

Is now the time to buy Transcat, or should you be careful about including it in your portfolio? Get the full stock story straight from our expert analysts, it’s free.

Why Is Transcat Not Exciting?

Even though the stock has become cheaper, we're sitting this one out for now. Here are three reasons why we avoid TRNS and a stock we'd rather own.

1. Weak Operating Margin Could Cause Trouble

Operating margin is one of the best measures of profitability because it tells us how much money a company takes home after procuring and manufacturing its products, marketing and selling those products, and most importantly, keeping them relevant through research and development.

Transcat’s operating margin might fluctuated slightly over the last 12 months but has generally stayed the same, averaging 7.1% over the last five years. This profitability was mediocre for an industrials business and caused by its suboptimal cost structure.

2. Previous Growth Initiatives Haven’t Impressed

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).

Transcat historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 8.7%, somewhat low compared to the best industrials companies that consistently pump out 20%+.

3. New Investments Fail to Bear Fruit as ROIC Declines

A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared 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, Transcat’s ROIC decreased by 4 percentage points annually over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.

Final Judgment

Transcat isn’t a terrible business, but it isn’t one of our picks. Following the recent decline, the stock trades at 37.8× forward P/E (or $87.50 per share). This multiple tells us a lot of good news is priced in - we think there are better opportunities elsewhere. We’d suggest looking at one of Charlie Munger’s all-time favorite businesses.

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