Over the last six months, Watsco’s shares have sunk to $386.88, producing a disappointing 9.1% loss - a stark contrast to the S&P 500’s 9.6% gain. This was partly due to its softer quarterly results and might have investors contemplating their next move.

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Even though the stock has become cheaper, we don't have much confidence in Watsco. Here are three reasons we avoid WSO and a stock we'd rather own.

In addition to reported revenue, same-store sales are a useful data point for analyzing Infrastructure Distributors companies. This metric measures the change in sales at brick-and-mortar locations that have existed for at least a year, giving visibility into Watsco’s underlying demand characteristics.

Over the last two years, Watsco failed to grow its same-store sales. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Watsco might have to change its strategy and pricing, which can disrupt operations.

While long-term earnings trends give us the big picture, we also track EPS over a shorter period because it can provide insight into an emerging theme or development for the business.

Sadly for Watsco, its EPS declined by 4.2% annually over the last two years while its revenue grew by 1%. This tells us the company became less profitable on a per-share basis as it expanded.

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. Over the last few years, Watsco’s ROIC has unfortunately decreased. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.

Watsco doesn’t pass our quality test. After the recent drawdown, the stock trades at 30.5× forward P/E (or $386.88 per share). This valuation tells us a lot of optimism is priced in - you can find more timely opportunities elsewhere. Let us point you toward the most dominant software business in the world.

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