Over the past six months, Avery Dennison’s shares (currently trading at $179.87) have posted a disappointing 11.8% loss while the S&P 500 was flat. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.
Is now the time to buy Avery Dennison, or should you be careful about including it in your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.
Why Do We Think Avery Dennison Will Underperform?
Even though the stock has become cheaper, we're sitting this one out for now. Here are three reasons why we avoid AVY and a stock we'd rather own.
1. Core Business Falling Behind as Demand Plateaus
Investors interested in Industrial Packaging companies should track organic revenue in addition to reported revenue. This metric gives visibility into Avery Dennison’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, Avery Dennison failed to grow its organic revenue. This performance was underwhelming and implies it may need to improve its products, pricing, or go-to-market strategy. It also suggests Avery Dennison might have to lean into acquisitions to accelerate growth, which isn’t ideal because M&A can be expensive and risky (integrations often disrupt focus). 
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, Avery Dennison’s margin dropped by 3.7 percentage points over the last five years. If its declines continue, it could signal increasing investment needs and capital intensity. Avery Dennison’s free cash flow margin for the trailing 12 months was 6.6%.
3. New Investments Fail to Bear Fruit as ROIC Declines
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, Avery Dennison’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.
Final Judgment
We see the value of companies helping their customers, but in the case of Avery Dennison, we’re out. After the recent drawdown, the stock trades at 17.4× forward P/E (or $179.87 per share). This valuation multiple is fair, but we don’t have much confidence in the company. There are superior stocks to buy right now. We’d suggest looking at a dominant Aerospace business that has perfected its M&A strategy.
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