Over the past six months, Donaldson’s shares (currently trading at $71.02) have posted a disappointing 5.6% 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 there a buying opportunity in Donaldson, 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 Is Donaldson Not Exciting?
Despite the more favorable entry price, we don't have much confidence in Donaldson. Here are three reasons why you should be careful with DCI and a stock we'd rather own.
1. Weak Constant Currency Growth Points to Soft Demand
In addition to reported revenue, constant currency revenue is a useful data point for analyzing Gas and Liquid Handling companies. This metric excludes currency movements, which are outside of Donaldson’s control and are not indicative of underlying demand.
Over the last two years, Donaldson’s constant currency revenue averaged 3.6% 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. Projected Revenue Growth Is Slim
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.
Over the next 12 months, sell-side analysts expect Donaldson’s revenue to rise by 2.3%, close to its 3.1% annualized growth for the past two years. This projection doesn't excite us and suggests its newer products and services will not accelerate its top-line performance yet.
3. 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, Donaldson’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. Donaldson’s free cash flow margin for the trailing 12 months was 9.5%.
Final Judgment
Donaldson isn’t a terrible business, but it isn’t one of our picks. Following the recent decline, the stock trades at 18.5× forward P/E (or $71.02 per share). Investors with a higher risk tolerance might like the company, but we think the potential downside is too great. We're fairly confident there are better investments elsewhere. We’d suggest looking at one of our top software and edge computing picks.
Stocks We Would Buy Instead of Donaldson
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