Oh, Shaw: Drop in stock is no buying opportunity

Q: What is the outlook for Shaw Group sgr? I've held it for five very profitable years and I wonder if I should stick with it.

A: When it comes to building a giant power plant, cleaning up hazardous materials or maintaining oil or gas facilities, Shaw Group is on the short list.

Shaw is one of a handful of companies around the world that specialize in big, complicated industrial projects that take a lot of know-how. And since the stock bottomed in 2003, it's been a huge winner for investors. Shares rocketed from $7 to nearly $75 in October 2007. Strong global demand for power production and energy has been a perfect environment for a company like Shaw Group.

But lately, the stock has been struggling. The price has faded back to around $53. Should you stick with it as momentum fades? Let's examine how it measures up to the four things we look at:

Step 1: Risk vs. reward. When you take a risk on a stock, you want to make sure you're properly rewarded. Downloading Shaw's trading history back to 1996, we see the company generated an average annual compound rate of return of 13.4%. That is a better-than-average return if you consider the Standard & Poor's 500 returned 8.1% annualized over the same time period.

But to get that return, you accepted incredibly high risk — standard deviation — of 105 percentage points. That's much higher than the S&P 500's risk of 17.4 percentage points during the same time period. While Shaw investors have enjoyed better-than-average returns, the risk has been much higher than the return. The extra risk you're taking is so much higher than the return, it's really not a great deal.

Step 2: Measure the stock's discounted cash flow. Some investors decide if a stock is pricey by comparing its current price to the present value of its expected cash flows. It's a complicated analysis made simple with a system from NewConstructs. When we run Shaw's stock, we find it's rated "dangerous." In other words, the current stock price is much higher than what the company is expected to generate in cash over it's lifetime. Using this analysis, it would appear Shaw's stock is pricey.

Step 3: Compare the stock's current valuation to its historical range. BetterInvesting's Stock Selection Guide can help. If the company can increase earnings 20% a year over the next five years, as analysts expect, that would put the stock in the "sell" range. That's a red light for investors who believe the price-to-earnings ratio will return to historical norms.

Step 4: Check the company's financial health. Before investing in any company, you want to make sure it's in good financial shape. A quick way to check is to look at where it falls on the USA TODAY Stock Meter, which ranks stocks from conservative (1) to aggressive (5). Shaw scores an aggressive 3.8 here. You can get a Stock Meter score for almost any stock by going to money.usatoday.com and putting the stock's ticker symbol or company name into the Get a Quote box.

The bottom line? You've made money on the stock, and you should be pleased. But at this point, based on these four steps, there's no compelling reason to stick with it. You should consider taking your money and finding something else to invest in.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns.