Value-focused investors are always on the hunt for stocks that are priced below their intrinsic value. One such stock that merits attention is Gen Digital Inc (GEN, Financial). The stock, which is currently priced at 20.85, recorded a gain of 2.81% in a day and a 3-month increase of 23.64%. The stock's fair valuation is $29.97, as indicated by its Fair Value (GF Value).
Understanding the GF Value
The GF Value represents the current intrinsic value of a stock derived from our exclusive method. The GF Value Line on our summary page gives an overview of the fair value that the stock should be traded at. It is calculated based on three factors:
- 1. Historical multiples (PE Ratio, PS Ratio, PB Ratio and Price-to-Free-Cash-Flow) that the stock has traded at.
- 2. GuruFocus adjustment factor based on the company's past returns and growth.
- 3. Future estimates of the business performance.
We believe the GF Value Line is the fair value that the stock should be traded at. The stock price will most likely fluctuate around the GF Value Line. If the stock price is significantly above the GF Value Line, it is overvalued and its future return is likely to be poor. On the other hand, if it is significantly below the GF Value Line, its future return will likely be higher.
However, investors need to consider a more in-depth analysis before making an investment decision. Despite its seemingly attractive valuation, certain risk factors associated with Gen Digital should not be ignored. These risks are primarily reflected through its low Altman Z-score of 0.92, and a Beneish M-Score of -1.41 that exceeds -1.78, the threshold for potential earnings manipulation. These indicators suggest that Gen Digital, despite its apparent undervaluation, might be a potential value trap. This complexity underlines the importance of thorough due diligence in investment decision-making.
Decoding the Altman Z-score and Beneish M-Score
Before delving into the details, let's understand what the Altman Z-score entails. Invented by New York University Professor Edward I. Altman in 1968, the Z-Score is a financial model that predicts the probability of a company entering bankruptcy within a two-year time frame. The Altman Z-Score combines five different financial ratios, each weighted to create a final score. A score below 1.8 suggests a high likelihood of financial distress, while a score above 3 indicates a low risk.
Developed by Professor Messod Beneish, the Beneish M-Score is based on eight financial variables that reflect different aspects of a company's financial performance and position. These are Days Sales Outstanding (DSO), Gross Margin (GM), Total Long-term Assets Less Property, Plant and Equipment over Total Assets (TATA), change in Revenue (∆REV), change in Depreciation and Amortization (∆DA), change in Selling, General and Admin expenses (∆SGA), change in Debt-to-Asset Ratio (∆LVG), and Net Income Less Non-Operating Income and Cash Flow from Operations over Total Assets (∆NOATA).
Company Snapshot: Gen Digital Inc
Gen Digital is a cybersecurity pure-play that offers security, identity protection, and privacy solutions to individual consumers. The firm's cyber safety offerings, via brands such as Norton, Avast, and LifeLock, have long maintained their positions as some of the most recognizable consumer-focused security and identity-protection products. With a market capitalization of $13.30 billion and sales of $3.60 billion, Gen Digital has an operating margin of 39.47%. The company's Return on Invested Capital (ROIC) stands at 16.69%, and its Weighted average cost of capital (WACC) is 7.5%.
Here is the income breakdown of Gen Digital: 
Breaking Down Gen Digital's Low Altman Z-Score
A dissection of Gen Digital's Altman Z-score reveals Gen Digital's financial health may be weak, suggesting possible financial distress:
The EBIT to Total Assets ratio serves as a crucial barometer of a company's operational effectiveness, correlating earnings before interest and taxes (EBIT) to total assets. An analysis of Gen Digital's EBIT to Total Assets ratio from historical data (2020: 0.16; 2021: 0.18; 2022: 0.18; 2023: 0.08) indicates a descending trend. This reduction suggests that Gen Digital might not be utilizing its assets to their full potential to generate operational profits, which could be negatively affecting the company's overall Z-score.
When it comes to operational efficiency, a vital indicator for Gen Digital is its asset turnover. The data: 2020: 0.19; 2021: 0.41; 2022: 0.42; 2023: 0.26 from the past three years suggests a recent decline following an initial increase in this ratio. The asset turnover ratio reflects how effectively a company is using its assets to generate sales. Therefore, a drop in this ratio can signify reduced operational efficiency, potentially due to underutilization of assets or decreased market demand for the company's products or services. This shift in Gen Digital's asset turnover underlines the need for the company to reassess its operational strategies to optimize asset usage and boost sales.
The days sales outstanding (DSO) is an important financial metric that denotes the average time a company takes to collect payment after a sale is completed. Looking at the historical data from the past three years (2020: 0.19; 2021: 0.41; 2022: 0.42; 2023: 0.26), there appears to be a recent surge following an initial decline in Gen Digital's DSO. An uptick in DSO might indicate aggressive revenue recognition practices, and in some cases, potential earnings manipulation. To explain, when DSO increases, it means the company's receivables are growing. This could be a result of sales being recorded before customers have paid, which inflates the revenue figures. In extreme cases, a company may even recognize revenue from sales that may never be collected, an action that is considered earnings manipulation. A rising DSO figure warrants scrutiny as it can signal financial distress or questionable accounting practices within the company. Therefore, investors should closely monitor such trends for early detection of any potential financial risks.
The Gross Margin index tracks the evolution of a company's gross profit as a proportion of its revenue. A downward trend could indicate issues such as overproduction or more generous credit terms, both of which are potential red flags for earnings manipulation. By examining the past three years of Gen Digital's historical data (2020: 84.39; 2021: 85.59; 2022: 85.52; 2023: 81.38), we find that its Gross Margin has contracted by 3.01%. Such a contraction in the gross margin can negatively impact the company's profitability as it signifies lesser income from each dollar of sales. This could put a strain on the company's capacity to manage operating costs, potentially undermining its financial stability.
The asset quality ratio, calculated as Total Long-term Assets minus Property, Plant, and Equipment, divided by Total Assets, gauges the proportion of intangible or less tangible assets within a company's asset structure. Analyzing Gen Digital's asset quality ratio over the past three years (2020: 0.67; 2021: 0.71; 2022: 0.72; 2023: 0.92), an increase might signal underlying issues, such as capitalizing normal operating expenses or goodwill impairment. These factors can inflate assets and mask true operational costs, potentially misrepresenting the company's actual financial position, and raising concerns for investors about its true value and risk profile.
The change in Selling, General, and Administrative (SG&A) expenses provides insight into a company's operational costs, encompassing expenses related to selling products and managing the business. Examining Gen Digital's SG&A data over the past three years (2020: 987; 2021: 794; 2022: 1,073; 2023: 945), an unexpected decrease may raise eyebrows. While reducing these expenses can be a sign of improved efficiency, an abrupt or unexplained decrease might indicate cost-cutting measures taken to artificially inflate earnings. By selectively reducing SG&A expenses, a company can create the illusion of higher profitability and operational efficiency. However, if these reductions are achieved by neglecting essential functions like marketing, customer service, or quality control, it might result in long-term negative effects on the company's growth, reputation, and sustainability. Hence, a decrease in SG&A must be carefully evaluated within the broader context of the company's strategy, industry norms, and competitive landscape to determine if it signals potential earnings manipulation or a legitimate improvement in operational efficiency.
The TATA (Total Accruals to Total Assets) ratio, calculated as the Net Income less Non-Operating Income and Cash Flow from Operations, divided by Total Assets, is a key indicator of the quality of a company's earnings. For Gen Digital, the current TATA ratio (TTM) stands at 0.043. A positive TATA ratio can be a warning sign, suggesting that the earnings are composed more of accruals rather than cash flow, which could be an indication of aggressive income recognition. Accrual accounting permits management some discretion in recognizing revenue and expenses, and a company intent on artificially boosting its earnings might exploit this flexibility. In essence, a higher TATA ratio might mean that the company's reported income is not as firmly grounded in real cash earnings, signaling poor quality of earnings, potentially resulting from accounting gimmicks or financial engineering rather than true operational performance. Investors and analysts should examine the components of the TATA ratio closely, especially when the value is positive, to understand the underlying drivers and assess whether it might indicate a need for more detailed scrutiny of the company's financial practices.
Conclusion: Gen Digital as a Potential Value Trap
Despite Gen Digital's seemingly undervalued status based on its GF Value, the company's low Altman Z-Score and high Beneish M-Score suggest potential financial distress and earnings manipulation. These risk factors, coupled with the company's deteriorating operational efficiency and questionable asset utilization, indicate that Gen Digital might be a potential value trap. Therefore, investors are advised to exercise caution and conduct thorough due diligence before making an investment decision.
GuruFocus Premium members can find stocks with high Altman Z-Score using the following
