The Misfits: Quanta Services (PWR)

The market treats Quanta much more favorably than it treats Quanta's largest competitor, EMCOR. It's hard to understand why.

Thunderstorm, Józef Chełmoński, 1896. oil on canvas (National Museum in Kraków)

The market may be irrational, but it isn’t stupid.

I’m pretty sure someone else has made that statement before, but I can’t remember who.

Every so often, the market presents situations that are hard to explain. Either it’s that a company’s stock is irrationally priced (either too expensive or too cheap), or it’s two seemingly close competitors whose stocks trade for wildly different valuations.

Whenever one of these situations presents itself, the easy (and hubristic) thing to do is proclaim “the market is irrational!” and act on your conviction. Our entire existence as individual stock pickers is based on this core idea. It is therefore hard to envision a world where the market is acting rationally.

Even if we believe the market is acting irrationally, there is always some logical thread behind that irrational behavior. As investors, a crucial skill is having the ability to understand the market’s logic thread and then assessing the rationality (or the degree of irrationality) of that thread.

I bring this up because it’s the lens through which I want to look at Quanta Services (NYSE: PWR). Quanta is the nation’s largest electrical contractor and has generated the types of returns you would expect from some Sillicon Valley darling over the past 20 years.

What I find peculiar about Quanta is how it compares to the #2 electrical contractor on the market, EMCOR Group (NYSE: EME). Quanta is considerably larger in terms of revenue and market capitalization. That said, many of the metrics we use to assess quality would suggest EMCOR is the better business. And yet, the market has almost always priced Quanta at a premium to EMCOR. Today, the market seems to think you should pay a premium that is double EMCOR’s to own Quanta.

The knee-jerk reaction is to say the market is irrational here. It was certainly mine, but I own shares of EMCOR, so I may perhaps be a little biased.

So let’s dig into why a company with seemingly better metrics trades at such a discount to its direct competitor and see what logic thread the market may be following to arrive at what looks like an irrational conclusion.

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