Value-focused investors are always on the hunt for stocks that are priced below their intrinsic value. One such stock that merits attention is Riot Platforms Inc (RIOT, Financial). The stock, which is currently priced at $10.58, recorded a gain of 13.34% in a day and a 3-month decrease of 8.8%. The stock's fair valuation is $18.56, as indicated by its 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 historical multiples (PE Ratio, PS Ratio, PB Ratio, and Price-to-Free-Cash-Flow) that the stock has traded at, GuruFocus adjustment factor based on the company's past returns and growth, and 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.
Identifying Potential Risks
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 Riot Platforms should not be ignored. These risks are primarily reflected through its low Beneish M-Score of -1.42 that exceeds -1.78, the threshold for potential earnings manipulation. These indicators suggest that Riot Platforms, 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 Beneish M-Score
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
Riot Platforms Inc is a vertically integrated Bitcoin mining company focused on building, supporting, and operating blockchain technologies. Distributed blockchain technology is a decentralized and encrypted ledger that is designed to offer a secure, efficient, verifiable, and permanent way of storing records and other information without the need for intermediaries. It serves as a medium of exchange, store of value, or unit of account. The company's segments include Bitcoin Mining; Data Center Hosting and Engineering. It generates maximum revenue from the Bitcoin Mining segment.
Financial Metrics Analysis
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 (2021: 0.20; 2022: 0.24; 2023: 0.19), there appears to be a rising trend in Riot Platforms'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 Riot Platforms's historical data (2021: 63.25; 2022: 49.59; 2023: 11.55), we find that its Gross Margin has contracted by 7.43%. 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 Riot Platforms's asset quality ratio over the past three years (2021: 0.52; 2022: 0.11; 2023: 0.12), 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 Year-Over-Year (YoY) change in Revenue calculates the percentage difference in sales between the previous year and the current year. A notable upswing in this ratio could potentially signal aggressive income recognition or sales manipulation tactics. Delving into Riot Platforms's revenue data over the past three years (2021: 65.30; 2022: 308.43; 2023: 256.41), it's apparent that there has been a significant surge in revenue in the last 12 months, with a rise of 372.33 %.
The change in Depreciation, Depletion, and Amortization (DDA) reflects the rate at which a company's assets lose value over time. Analyzing Riot Platforms's DDA data over the past three years (2021: 11.36; 2022: 52.77; 2023: 210.83), a decreasing rate might be a cause for concern. This decline may suggest that the company is prolonging the useful life of its assets, possibly to manipulate earnings. By extending the lifespan of assets, depreciation charges are spread over a longer period, thereby reducing annual expenses and artificially boosting reported profits. While this may create a more favorable short-term financial picture, it could also distort the true value and condition of the company's assets, misleading investors and potentially hiding underlying operational or financial issues.
Conclusion
In conclusion, despite Riot Platforms's seemingly attractive valuation, the company exhibits several warning signs that suggest it might be a potential value trap. The combination of a low Beneish M-Score, increasing DSO, contracting Gross Margin, and decreasing DDA paints a picture of potential earnings manipulation and financial instability. Therefore, investors should exercise caution and conduct thorough due diligence before investing in Riot Platforms.
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