The Competitive Advantage Period and Kors's Price
All assets should carry a price tag related to their short- and long-term capability to produce cash flows for shareholders. Their ability will be related to their pricing power which is related to the barriers to entry a company builds around its business castle - its business motto in Buffett's words. Then, the longest a company can sustain high margins and stable or growing sales, the more valuable it will be.
The market seems to be convinced about Kors' ability to keep its high-growth and high-margins momentum going. The company now sells for 26 times forward earnings against Coach (NYSE:COH)'s 15 times earnings multiple or LVMH Moet Hennessy Louis Vuitton's (LVMUY) 18 times earnings multiple. Of course this valuation gap can be justified if Kors' EPS do grow by about 30% year over year for at least the next five years. As a matter of fact, Coach's EPS will surely diminish in 2014, and LVMH is expected to grow its EPS by 11% year over year.
Nevertheless, past performance is not always a good indicator of future performance. Other fashion labels such as Abercrombie & Fitch (NYSE:ANF) grew fast until one day they just did not grow anymore. The brands just came out of fashion. This, of course, had terrible effects on investors who had made a bet at high multiples. When Abercrombie & Fitch's stock was selling for $70 in 2011, most analysts gave the stock a target well above that figure. Abercrombie & Fitch now trades around $33 per share.
When you pay high multiples you are paying for future unwarranted growth that might not be there when the time comes. Kors could turn out to be a great brand that produces high cash flow yields eternally the way Louis Vuitton and Hermes do it for their shareholders. But it might also turn out to be another Abercrombie & Fitch.
Kors has been great for its early investors. The stock has returned nearly 300% to its shareholders since its 2011 initial public offering. But right now you might be paying a huge premium for growth that might not meet expectations. A great investor once told me that happiness equals reality minus expectations – not only in investing but on all life matters. With this in mind, we should all know that even a great reality like an EPS growth of 20% year over year might disappoint the market and make you lose money if you got into the company's shares at the current valuation level. If you decide to buy Kors shares now, beware. You might pay now for something that might not be what everyone seems to be expecting.