Typically, when a company beats analyst estimates for quarterly earnings and also raises its guidance, shares rally. That wasn't the case for global positioning system (GPS) device company Garmin (GRMN 1.80%) last week.
The company topped the analyst consensus for earnings per share (EPS) by more than 10%, and management boosted its top and bottom-line outlook for the full year. That was the second time in the last two quarters management has increased its guidance. It's worth understanding why investors sold the stock in response to the report, and consider whether this represents a good opportunity to buy into a company that has outperformed the S&P 500 over the last three-year, five-year, and 10-year periods.
Image source: Getty Images.
What sellers are seeing
Garmin came off a solid year in 2020 with revenue jumping 11%, even with a temporary slowdown from the pandemic factored in. Management predicted that momentum would continue into 2021, initially calling for another year of 10% growth. But after the third-quarter report -- and Garmin's second revision to its full-year guidance -- the company now sees revenue growing 18% versus 2020.
So why did investors sell on that news? For one thing, the latest guidance only increased about 1% to 2% from the prior revenue and EPS figures. And with Garmin shares having gained more than 60% in the 12 months leading up to the earnings report, investors seem to have expected more from the outlook.
Another factor is a common theme among many companies right now. In the earnings call, CEO Cliff Pemble addressed the decline in year-over-year operating income, saying it was "due to a combination of higher freight costs affecting gross margin and increased expenses as we invest in R&D, information technology and marketing initiatives." Gross margin, in fact, dropped for the second consecutive quarter, partially because production and input costs have risen.
What they are missing
In the big picture, the company anticipates gross margin for 2021 to still be a healthy 58.2% with EPS growing 9% for the year. And the trends that have driven sales growth over the past two years continue. Boat manufacturers have record backlogs, and interest in outdoor recreation that spiked during the pandemic doesn't seem to be waning.
Ultimately, it seems the stock price got ahead of itself, and this quarter marked a bit of a correction. Garmin's price-to-earnings (P/E) ratio was approaching 30 in the most recent quarter, which was the highest it has been over the past several years.
Data by YCharts.
Setting up a better valuation
The subsequent drop in the share price after the earnings announcement brought that valuation metric closer to the top of its recent range. If one considers that sales growth should continue, even at a slower rate than in 2021, the forward P/E would be more in line with the low 20s that it has held fairly consistently, with the exception of the pandemic-related bear market.
Investors should also consider the dividend, which yields about 1.9% as of this writing, and Garmin's strong balance sheet with $2 billion in cash and marketable securities and no debt. If one believes the strength of this business will continue, and cost pressures will abate or at least level out, Garmin's recent sell-off becomes an attractive entry point for both new and existing shareholders.
