Over the past six months, A. O. Smith’s stock price fell to $71.26. Shareholders have lost 18.8% of their capital, which is disappointing considering the S&P 500 has climbed by 3.8%. This might have investors contemplating their next move.
Is there a buying opportunity in A. O. Smith, 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.
Even though the stock has become cheaper, we're sitting this one out for now. Here are three reasons why you should be careful with AOS and a stock we'd rather own.
Why Is A. O. Smith Not Exciting?
Credited with the invention of the glass-lined water heater, A.O. Smith (NYSE:AOS) manufactures water heating and treatment products for various industries.
1. Slow Organic Growth Suggests Waning Demand In Core Business
In addition to reported revenue, organic revenue is a useful data point for analyzing HVAC and Water Systems companies. 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’s organic revenue averaged 2.2% year-on-year growth. This performance was underwhelming and suggests it may need to improve its products, pricing, or go-to-market strategy, which can add an extra layer of complexity to its operations. 
2. Projected Revenue Growth Is Slim
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.
Over the next 12 months, sell-side analysts expect A. O. Smith’s revenue to rise by 2%, close to its 1.1% annualized growth for the past two years. This projection doesn't excite us and implies its newer products and services will not lead to better top-line performance yet.
3. 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, A. O. Smith’s margin dropped by 3.8 percentage points over the last five years. If its declines continue, it could signal higher capital intensity. A. O. Smith’s free cash flow margin for the trailing 12 months was 12.4%.
Final Judgment
A. O. Smith isn’t a terrible business, but it doesn’t pass our bar. After the recent drawdown, the stock trades at 17.9× forward price-to-earnings (or $71.26 per share). Beauty is in the eye of the beholder, but our analysis shows the upside isn’t great compared to the potential downside. We're pretty confident there are superior stocks to buy right now. Let us point you toward Google, whose cloud computing and YouTube divisions are firing on all cylinders.
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