Hertz’s 37.4% return over the past six months has outpaced the S&P 500 by 28.2%, and its stock price has climbed to $5.73 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.

Is there a buying opportunity in Hertz, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.

Why Do We Think Hertz Will Underperform?

We’re happy investors have made money, but we're sitting this one out for now. Here are three reasons you should be careful with HTZ and a stock we'd rather own.

1. Weak Sales Volumes Indicate Waning Demand

Revenue growth can be broken down into changes in price and volume (the number of units sold). While both are important, volume is the lifeblood of a successful Ground Transportation company because there’s a ceiling to what customers will pay.

Hertz’s units sold came in at 38.7 million in the latest quarter, and over the last two years, averaged 2.2% year-on-year growth. This performance was underwhelming and suggests it might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability.

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

3. Short Cash Runway Exposes Shareholders to Potential Dilution

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

Hertz burned through $737 million of cash over the last year, and its $20.56 billion of debt exceeds the $1.13 billion of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

Unless the Hertz’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.

We remain cautious of Hertz until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.

Final Judgment

Hertz doesn’t pass our quality test. With its shares outperforming the market lately, the stock trades at 4.2× forward EV-to-EBITDA (or $5.73 per share). This valuation is reasonable, but the company’s shaky fundamentals present too much downside risk. There are better stocks to buy right now. We’d recommend looking at the Amazon and PayPal of Latin America.

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