World's Scariest Stock: Crocs

My kids have these nice, lightweight shoes made from some sort of fluffy rubber. They're perforated all over, and you can buy little brooches that snap into the holes. My son's black clogs are full of Spider-Man mementos, and my daughter's pink-and-whites look like Cinderella's after-party. Yeah, those Skechers (NYSE: SKX  ) are pretty nice.

Oh, you were expecting a different brand? Sorry, but the actual Crocs (Nasdaq: CROX  ) are way too pricey, and we shop at Gymboree (Nasdaq: GYMB  ) on a regular basis. Skechers is just one of an avalanche of shoemakers who have copied the Crocs concept already, and the knock-offs are available everywhere at reasonable prices. They're often backed by other household names like Skechers or Collective Brands' Payless ShoeSource (NYSE: PSS  ) , and they come in a cornucopia of colors and styles, most of which accept those snazzy decoration plug-ins.

The kids' closet even contains an unbranded pair, stamped "Made in China" but otherwise unidentifiable. And that pair looks just as good -- or ugly, depending on your opinion -- as the others.

I can certainly see the attraction of light, breathable, and overdesigned footwear, especially here in sunny Florida. But Crocs lost the first-mover advantage a long time ago, and it's only a question of time before the brand itself fades into the linguistic mists of time.

It's too early to pass definitive judgment on Google (Nasdaq: GOOG  ) yet, but longtime holders of other brands that became commodity dictionary terms can tell you what happened to their competitive moats: They disappeared.

I can take the heat!
So you're not scared yet? OK. Then think about valuation for a minute. Maybe you don't mind a price-to-earnings ratio around 46 times trailing earnings. Perhaps the company is worth trading at nine times trailing sales, or 44 times cash flow. It's a growing puppy, you know?

Yes, but cash doesn't lie. Let's run the stock through a remarkably generous discounted cash flow exercise, shall we?

Even in Fantasyland, this stock is too expensive
The current analyst guesstimate points to 27% income growth over the next five years. Let's bump that up to 30% -- nearly quadrupling earnings over that period -- and then ticking down to 15% for five years and an inflation-beating 4% forevermore. Then let's pretend that free cash flow is equal to operating cash flow, despite the blatantly ridiculous lenience of that assumption. And let's say that Crocs is no riskier an investment than any mass-market, big-box retailer, so the discount rate stays at a low, low 10%.

There's just no way that all these loose assumptions can come true. The operating cash flow substitution is particularly heinous, and none of the growth numbers accounts for the knock-offs stealing market share. Reality will most assuredly come in way below the output from this run, but we're in Fantasyland today, and reality doesn't matter.

And even then, the company should be worth just $3.6 billion today. It's overvalued by 40% over the ideal dream picture we just painted. It's enough to scare me, who bought Google shares at almost $500 a pop.

Stick to candy
If you want something light and sweet in pastel shades of orange and brown, stick with candy corn this Halloween. You let Crocs into your portfolio only at your own peril. The massacre will come in the dead of night, and it'll be scary. Don't buy the hype.

Do you agree? Think I'm overstating the fright factor? Click on over to our Motley Fool CAPS community and tell us what you think. A thumbs-down vote for Crocs is a vote for sanity. And after a spaced-out valuation fantasy like this one, you might want to go to Philip Durell's Turkish valuation steam bath, also known as the Inside Value newsletter. One free 30-day trial is guaranteed to ease your worried mind.

Further Foolishness:

Want to know what other companies give us the frights? You can view the rest of our hair-raising stocks here.


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