Small cap? Check.
Wide market opportunity? Definitely.
High insider ownership and recent insider buying? Oh, yeah.
Broken stock price? That, too.
The stock I'm talking about has all the makings of one of the market's best stocks. Yet a series of operational missteps has kept the stock essentially flat since its 1995 IPO. But with a turnaround strategy in place, this could finally be the start of something great for investors in Oakley (NYSE:OO).
The Oakley overview
Oakley is a consumer-products maker best known for its sunglasses. The company was founded by Jim Jannard -- a born entrepreneur who never finished college -- in 1975. Despite its best-in-class eyewear, strong brand, and a dedicated founder who continues to own a significant stake in the company, Oakley has never been a good investment. Much of that can be attributed to the company's previous failures to focus on what it does best -- eyewear -- in favor of overreaching into markets where it was unable to compete.
Jannard's own competitive nature was part of the reason Oakley expanded too far, too fast. Jannard's decision to sign Nike (NYSE:NKE) spokesman Michael Jordan in the late 1990s seemed to rile longtime Jannard buddy and Nike head Phil Knight. So Nike introduced eyewear to compete with Oakley; in response, Jannard had Oakley venture into footwear and apparel.
The arms race with Nike was terrible for Oakley. The company, unfocused in its expansion, saw its impressive revenue growth eroded by skyrocketing expenses and contracting margins.
Oakley's lack of focus and fiscal irresponsibility also hurt the balance sheet, causing the company to take on more than $20 million of long-term debt in 1997. But the company has strengthened its balance sheet since then, paying the debt down to $8 million today (against more than $30 million in cash).
The new Oakley
But the company has learned from its missteps. As Oakley embarks on its new growth plan under new CEO Scott Olivet, there is every reason to believe that it will focus on its core eyewear business, properly allocate capital, and benefit from a huge demographic trend that has more and more young people embracing alternative sports such as surfing, mountain biking, and snowboarding -- a trend that is already spurring remarkable growth at Pacific Sunwear (NASDAQ:PSUN) and Hidden Gems recommendations Zumiez (NASDAQ:ZUMZ) and Volcom (NASDAQ:VLCM).
The key to this strategy is to continue making high-quality sunglasses, but rein in the apparel, footwear, and accessories lines so they complement the company's core segments: surfing, mountain sports, and to a slightly lesser extent, golf.
Oakley's turnaround won't happen overnight, but the company's strong brand, newly focused strategy, and incredibly competitive founder can be had today for a very good price.
A reasonable valuation
Oakley trades for 21 times earnings and its enterprise value is 10 times EBITDA. While that doesn't scream "cheap" on the surface, both multiples are far less than what you'd have to cough up to own Zumiez or Volcom. However, Oakley's shares are cheaper for a reason. Earnings are lumpy at the company, which has yet to prove that it can deliver on its promises.
Nevertheless, there's minimal dilution in Oakley shares, and the company even pays a modest 1% dividend. While neither of these traits is remarkable on its own, together they support the thesis that Oakley's management is focused on fiscal responsibility. This idea is crucial to being able to forecast margin expansion and more consistent earnings over the next few years.
And extraordinary management incentives
Back in March, Jannard purchased nearly $1.7 million worth of shares. That kind of active insider buying -- also undertaken recently by Michael Dell at Dell (NASDAQ:DELL) and Aubrey McClendon at Chesapeake Energy (NYSE:CHK) -- can generally be viewed as a insider tip that the stock offers a lot of potential upside.
Jannard now owns now owns nearly 65% of Oakley, a significant ownership position that is rare in today's public markets and correlates with outsized long-term returns.
The Foolish bottom line
There is a lot of untapped value in the Oakley brand, its products, and its retail efforts. Should the company's refocused management team succeed with its turnaround plan, I estimate Oakley's value will be close to $2.5 billion in 2011 (based on 12% revenue growth, modest margin expansion, and the company maintaining its current multiple). That would provide current investors with attractive 17.25% annualized returns from here.
We study small caps such as Oakley very closely at Motley Fool Hidden Gems, and Fool co-founder Tom Gardner and senior analyst Bill Mann recommend two small-cap opportunities each month to our members -- stocks that they believe can surpass even 17.25% annualized returns. Their picks have returned 31% on average to date, vs. just 10% for the S&P 500. The secret to that success is finding small, well-managed companies with wide market opportunities and broken stock prices -- traits that I believe Oakley possesses today. If you'd like to learn more about this market-beating service and check out all of our small-cap ideas free for 30 days, click here. There's no obligation to subscribe.
Tim Hanson does not own shares of any company mentioned in this article. Pacific Sunwear and Dell are Stock Advisor recommendations. Dell is also an Inside Value recommendation. No Fool is too cool fordisclosure.
