I found three investment ideas at my front door today.
The shoe basket to the left stores my daughter's Crocs
What they do
I would be surprised if you haven't heard of these companies. But just in case, here's what they do. Crocs makes what could be the funkiest footwear I have ever seen. Its brightly colored elastomer shoes with the big holes in the front may look strange, but once you put a pair on your feet, it's tough to take them off.
Under Armour, a Motley Fool Rule Breakers selection, manufactures athletic apparel. It's best known for its compression gear, but Under Armour is expanding its product line. More products with the Under Armour logo should lead to a stronger brand.
Heelys are the latest sensation for kids. With a built-in wheel in the heel, my daughter and her friends get running starts, lean back, put one foot in front of the other, and roll their way to fun. I have to admit that I thought they were annoying at first, but their smiling faces changed my mind.
Great performance
Good investments require more than just a good story. Companies need to perform. And it's important to make good comparisons (opens a .pdf file) with a few other companies. I've picked footwear maker Deckers Outdoor
|
Crocs |
Under Armour |
Heelys |
Deckers Outdoor |
Hansen Natural |
|
|---|---|---|---|---|---|
|
Sales Growth (LTM) |
243% |
53% |
458%* |
9.3% |
92.9% |
|
Op. Margin (LTM) |
29.2% |
13.3% |
22.8% |
19.8% |
30.8% |
|
ROIC** |
95.6% |
30.8% |
73.5% |
26.3% |
95.3% |
Data from Capital IQ. ROIC uses Capital IQ data and author calculation.
*Quarter-over-quarter comparison
**For the last full-year of data
All I can say is, "Wow!" Those are some impressive numbers. No wonder these stocks have been going up. Before we rush out to buy them, let's look at one more thing.
Relative comparisons
Let me start off by saying that I am not using a ratio to make a valuation. Ratios are shorthand valuations, can be used to make relative comparisons, but come with their own set of issues. However, we can use ratios to gather information, and that's what we'll do here.
The enterprise value to operating income ratio (EV/EBIT) compares the overall value of a company to the amount of operating income it generates. This ratio lets investors compare companies with capital structure differences as well as different tax situations. The table below lists the results.
|
Crocs |
Under Armour |
Heelys |
Deckers Outdoor |
Hansen Natural |
|
|---|---|---|---|---|---|
|
EV/EBIT |
25.2 |
39.1 |
33.9 |
13.9 |
23.3 |
Clearly, the market is willing to pay a high price relative to the operating earnings at Under Armor and Heelys. It's willing to pay a bit less for Crocs and Hansen Natural. My former Motley Fool Hidden Gems recommendation Deckers Outdoor is at the bottom of the list.
Great expectations?
When a ratio like this is high, two things could be going on. First, investors could be paying too high a price: Market capitalization, the stock price multiplied by the number of shares outstanding, is a significant part of enterprise value. The other thing that could be happening is that the denominator, operating earnings, could be small, making the ratio look large.
Let's assume for a moment that the stock market price is a good estimate of the value of the company. That would imply that the market expects operating earnings to grow in the future. I have to say that as a value investor, this situation scares me. I don't want to pay a high price for anything, let alone great expectations. If the expectations imbedded in the high price are not met, the market, which discounts the future, will revise its value downward, causing my investment to lose value.
However, if I understand the business well enough to make a good judgment of the future cash flows, and that estimate is less than the current price, then the stocks could still offer attractive investment opportunities. That's why it's important to learn about how a business works and to model the value of that business as best I can. Ratios only tell me what the market thinks; I have to be able to compare the value with what I think for the ratio to have meaning.
The Foolish bottom line
Their businesses are growing fast. Their products are ubiquitous. Their business models are lean and generate incredible returns on capital. Their stocks are hot.
I can say with confidence that these are some great businesses. But I can't justify making an investment in their stocks. It's the classic struggle: Great company, lousy investment. In fact, given their high prices and the expectations built into those prices, I should probably consider shorting them or at least giving them an underperform rating in Motley Fool CAPS. Unfortunately, I think the nature of their businesses and the current momentum driving their stock's prices would make that a risky endeavor. Shorting is a scary process to me -- why should I play a game with limited upside and unlimited downside when I don't have an advantage? So I'll just let these stocks pass and admire all the tricks my daughter and her friends can do in the Heelys.
For more on these great companies, check out:
Deckers Outdoor used to be a Hidden Gemsrecommendation. To find out more about how small-cap stocks can have a big impact on your portfolio, take a free 30-day trial to the newsletter.
Retail editor and Inside Value team member David Meier owns shares of Deckers Outdoor but does not own shares in any of the other companies mentioned. He is ranked 242 out of 22,891 investors in CAPS, the Fool's rating service. You can view his TMF profile here. The Fool takes its disclosure policy very seriously.
