Why I Sold This Stock
Q.E.P. Co., Inc. (QEPC)
I first came across QEPC thanks to Dirt from Dirt Cheap Stocks. If you haven’t followed him on Substack, do yourself a favor and check him out. His approach reminds me a lot of a young Warren Buffett—seeking undervalued stocks in the microcap space. For more details about the business, you can also read here. Back in October 2023, I bought QEPC, and since then, the stock has appreciated about 35%. Despite this solid run, I’ve recently decided to exit my position. Here’s why.
My Rationale for Selling
While the turnaround story is undeniably impressive, my decision to exit ultimately hinged on a structural concern that remains unresolved: customer concentration.
QEPC derives roughly two-thirds of its revenue from Home Depot—a relationship that has been a cornerstone of its success for over 40 years. Historically, riding the Home Depot wave helped Q.E.P. flourish. However, Home Depot is now evolving its own brand portfolio, which increasingly competes directly with suppliers like QEPC.
Even if we assume this brand’s longevity persists for another 40 years—an 80-year lifespan for a consumer brand is long by any measure—the Rule of 72 suggests an annual "fade" rate of approximately 1.8% (72 ÷ 40 = 1.8%). You can adjust this assumption based on your outlook; for instance, if you believe the brand will last only 20 more years, the fade rate would be even steeper.
At its current valuation, QEPC trades at roughly 9x P/E for 2024. A 9x P/E implies an earnings yield of approximately 11% (1/9 = 11.1%). However, when you incorporate the annual earnings fade of 1.8% due to the potential erosion of Home Depot’s business over time, the adjusted return drops to about 9.2% per year (11% - 1.8% = 9.2%).
For a no-growth business, a 9x P/E is fair enough. I’ve chosen to use the P/E multiple rather than EBITDA-based metrics because depreciation is a real expense that significantly impacts earnings. This is especially relevant given recent trends: capital expenditures totaled 3380 million in the first nine months of 2024 up from 2603 million during the same period in 2023. Rising capex suggests that depreciation—a non-cash expense that still reflects the real cost of maintaining or replacing assets—will likely increase over time.
However, when you factor in the annual earnings fade of 1.8%, the long-term return prospects become less attractive. Simply put, even though management has done an excellent job executing a turnaround—selling off noncore assets, paying down debt, and returning capital—the heavy reliance on Home Depot remains a risk that could slowly undermine future earnings.
With a low multiple of 9x P/E, a potential fade factor built into the earnings, and rising capital expenditures that may pressure cash flows, the expected returns over my intended holding period no longer justify the risk.