Although Covenant Logistics (currently trading at $25.61 per share) has gained 6.2% over the last six months, it has trailed the S&P 500’s 11.5% return during that period. This might have investors contemplating their next move.

Is there a buying opportunity in Covenant Logistics, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.

Why Do We Think Covenant Logistics Will Underperform?

We're cautious about Covenant Logistics. Here are three reasons we avoid CVLG and a stock we'd rather own.

1. Long-Term Revenue Growth Disappoints

A company’s long-term sales performance can indicate its overall quality. Any business can have short-term success, but a top-tier one grows for years. Regrettably, Covenant Logistics’s sales grew at a mediocre 6.3% compounded annual growth rate over the last five years. This fell short of our benchmark for the industrials sector.

2. 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, Covenant Logistics’s margin dropped by 12.3 percentage points over the last five years. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. Almost any movement in the wrong direction is undesirable because of its relatively low cash conversion. If the longer-term trend returns, it could signal it’s becoming a more capital-intensive business. Covenant Logistics’s free cash flow margin for the trailing 12 months was 1.5%.

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

Final Judgment

Covenant Logistics doesn’t pass our quality test. With its shares lagging the market recently, the stock trades at 14.2× forward P/E (or $25.61 per share). This valuation multiple is fair, but we don’t have much confidence in the company. There are better investments elsewhere. We’d suggest looking at one of our top digital advertising picks.

Stocks We Would Buy Instead of Covenant Logistics

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