5 Reasons Avon Lost Big in 2012

As the year ends, it's high time to take a look at what happened to the stocks you follow. If you know the reasons behind a company's stumblings or successes, then you can make a better decision about whether its stock justifies a spot in your portfolio.

We're going to look at Avon Products (AVP), a company whose army of sales reps, vast emerging-market exposure, and low-cost business model haven't been enough to keep the retailer's stock afloat. Here are five reasons Avon's stock has suffered so horribly this year.

Shrinking sales force
Avon possesses substantial emerging-market growth potential, but its number of independent reps has declined in every market except Latin America, South Africa, and Turkey. Although revenues from Latin America grew more than 10% each year in 2011 and 2010, operating margins declined both years. But with almost half of Avon's revenues already derived from Latin America, it'll be difficult for this geographic region to pick up the slack of lost sales reps in nearly every other market around the globe.

Snubbed Coty bids
Interested in Avon's strong Latin American presence, fragrance maker Coty made a generous offer to  buy out Avon in May. Yet the financial backing of Warren Buffett's Berkshire Hathaway (BRK.B -0.74%) wasn't enough for Avon management to bite. Avon is currently entangled in lawsuits claiming it wasn't acting in shareholders' best interests by rejecting the deal.  

Since Coty withdrew its offer, Avon stock has dropped nearly 34%.Meanwhile, the S&P Retail Index has increased roughly 7% during this time. Coty filed to go public in late Juneand is scheduled to IPO in the first quarter of 2013.

Dwindling margins
Avon's razor-thin current 1% profit margin has declined more than 25% in the past two years. The company's return on equity has also declined. Avon's selling, general, and administrative expenses outpace total revenue, and its operating margins have declined significantly during the past several years, including a 23% reduction in 2011. Any one of these characteristics is unsavory. But, in total, they're a horrific combination.

Unsustainable dividend and unappealing debt
Take a look at how Avon stacks up against the competition in terms of its dividend and debt load.

Source: Yahoo! Finance. 

Avon's payout ratio is more than 100%, which means the company pays its shareholders dividends that are greater than its earnings. The company's trailing annual dividend yield is 5.4%, and its five-year average dividend yield is 3.2%. While profit margins have been dwindling, the company has continued to pay a dividend. Both Herbalife and Nu Skin pay slightly better dividends, and at ratios that are not only sustainable but also offer the companies room to grow their dividends in the future. Ulta Salons doesn't pay a dividend.

Arguably worse than its dividend situation, Avon's debt-to-equity ratio is nearly twice that of Herbalife and almost six times worse than Nu Skin. Ulta has no long-term debt on its balance sheet.

We can see how this has affected the stock performance.

AVP Total Return Price data by YCharts.

Avon's stock has lost nearly 18% year to date. Herbalife and Nu Skin are both down roughly 10% and 5%, respectively, during the same period. Ulta Salon has enjoyed a meteoric 58% run-up in its stock price. Meanwhile, the S&P 500 is up nearly 13% year to date.

The nature of Avon's direct-selling business model should allow it to enjoy cost advantages because it eliminates wholesale, retail, and advertising expenses. But both Herbalife, which has a similar business model, and bricks-and-mortar retailer Ulta enjoy much better metrics than Avon's -- namely, half the SG&A as a percent of revenues and nearly twice the operating margins. 

Foolish bottom line
If you're still holding on to Avon, strongly consider the company's legal troubles, loss of sales reps, shrinking margins, shaky dividend, and undesirable debt load. It's high time to cut your losses and make 2013 a better investing year.