Under Armour Doesn't Cover the Spread

Under Armour (Nasdaq: UARM  ) reported a solid second quarter. Compared to the previous year, revenue was up 63%, and earnings were up 33%. Earnings per share were $0.05, and analysts were only expecting $0.02. Yet the stock fell over $2 after results were released. According to Raymond James analyst Dan Wewer, the stock fell because "Under Armour did not generate the same magnitude of upside surprise as it has in past quarters." In other words, the company beat estimates, just not by enough.

This is a good illustration of the dangers of high expectations. For Under Armour, tremendous expectations are priced into the stock, and as a result the company needs to hit a home run every quarter or the stock will plummet. This quarter, the company beat analyst estimates, and the stock fell by a few dollars. Imagine how much the stock will fall if Under Armour misses expected earnings.

These expectations don't just apply to the short term. The consensus Wall Street estimates for revenue are approximately $400 million in 2006 and $500 million in 2007. Last year, the company recorded $281 million in revenue. That means the expectation is to deliver 40% revenue growth in 2006 and long-term earnings growth of over 22% annually. With a trailing P/E of 80, that expectation is more than priced into the stock. So investors should not expect to be rewarded unless Under Armour exceeds 40% revenue growth and $0.66 in earnings per share.

That isn't to say the company will not meet expectations. In fact, Under Armour has a decent chance of coming through for investors in 2006. First, CEO Kevin Plank has confirmed guidance of $400 million to $410 million in 2006 net revenues and $0.68 to $0.70 per share in earnings. Second, the company grew revenue by 78% in 2004 and 37% in 2005. Given that track record, 40% revenue growth is reasonable. Third, the company has $167 million in revenue and $11.2 million in net income for the first half of 2006, which is right on pace. If the company has a reasonable third quarter and a good holiday season, $400 million is definitely achievable. Assuming the company can maintain a net margin of over 10% for the second half of 2006, it would earn $35 million. Although this will be difficult, especially considering it hasn't done so historically, I trust management enough to be confident in its guidance.

Of course, this is all very speculative. Under Armour is still in a growth phase, and predicting the future isn't as easy as it sounds. For something less volatile, investors would do well to check out footwear king Nike (NYSE: NKE  ) , or for something cheaper, K-Swiss (Nasdaq: KSWS  ) .

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Fool contributor Brendan Mathews welcomes your feedback. He also finds it ironic that Ralph Friedgen is helping to sell skin-tight compression shirts. Brendan owns shares of Nike. The Motley Fool has a strict disclosure policy.

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