Looking for bargains in fashion related stocks can be a profitable endeavor. These shares have a tendency to be in great favor when things are going well and quickly fall out of favor when results don't meet expectations. Investors can often take advantage of the resulting excessively high or low valuation.
The vacillating attitude of these stocks can begin when a company gradually increases its sales and the share price soon follows. Momentum begins to build and Wall Street starts to notice. Soon optimistic coverage on the company is issued and that furthers the fervent stock price rise.
Eventually growth falters. Expectations often get too high, the company misses overly enthusiastic estimates and the share price weakens. If poor performance continues, the opinion on the stock darkens and the price continues to fall. It usually doesn't take long for the previously loved shares to quickly become a market outcast.
It is often when the sentiment turns so pessimistic that the shares offer an attractive valuation. Then, because expectations get so depressed, the company has a much easier time beating lowered forecasts and the stock price recovers.
Gap and Abercrombie & Fitch are a couple examples where I’ve seen this pattern play out.
Gap had lost market favor with weak same-store sales figures in 2010 and 2011. Same-store sales, or sales for stores opened for at least a year, is a key metric for retailers. Pessimism about the company's future grew and its valuation fell as sales figures lagged and earnings stagnated.
But Gap saw things improve in 2012. Same-store sales rose and the company's results met analyst forecasts. Optimism returned as Gap raised its guidance and the stock, which had been shunned, rose as it was again highly regarded on the Street.
Abercrombie & Fitch had been struggling in early 2012. The company reported that first-quarter net income shrank because of higher costs and declining sales in established stores and in Europe. Total sales rose 10 percent but fell short of expectations. The share price fell from $50 to $30.
Then, in October 2012, Abercrombie & Fitch stunned investors with an unexpectedly improved quarterly result and a full-year outlook that exceeded Street forecasts. This drove shares higher as investors regained their optimism on the company’s future.
These examples show the benefit of taking advantage of fickle Street opinion in fashion related stocks. But to increase the odds of making a profitable transaction, investors need to feel comfortable that the underlying company can weather a short-term downturn in operations. The bigger the company is, the better brand reputation, the more cash on hand and the lower the debt burden are all factors that will help the enterprise get through tough times, improve performance and recover share price.
I'm currently watching three stocks where a market sentiment change might offer an opportunity.
The Jones Group
The Jones Group (JNY) has little stock market favor. The company had a tepid 2011, reporting revenue of $3.78 billion compared with $3.64 billion for 2010 and earnings per share of $1.30 as compared with $1.51 per share in the prior year. It has also shown little improvement in 2012.
But there is the potential for progress. Jones has expanded in the lucrative luxury footwear business with a couple of recent acquisitions. The company is also closing under performing retail locations, 85 through Sept. 2012, which should help profitability. They could also have better year-over-year comparisons in their critical wholesale sportswear business, but the company’s relatively high debt load could be a burden.
With any sort of improvement, the stock might get closer to my fair value estimate of $16 per share based on revenue of $3.8 billion, average adjusted cash earnings of $127 million and a 10x multiple.
Urban Outfitters (URBN) recently reported a 15% sales increase for the holiday season. The Street’s view also looks to be improving with the stock hitting a recent 52-week high of around $43 a share.
The total sales increase can be attributed to growth in new store openings and a 38% increase in online sales. The bad news is same-store sales declined by 1%.
Relative to my fair value estimate, the stock might be showing a bit too much optimism. Fair value looks to be around $36 a share based on revenue of $3.2 billion, average adjusted cash earnings of $323 million and a 16x multiple.
Deckers (DECK) has seen a gradual loss of Street favor culminating with a terrible third quarter 2012 report. The company's sales dropped to $376 million from $414 million in the prior year and earnings fell to $1.18 per share from $1.59 in 2011. The company’s main brand, UGG, saw sales decrease 11.8% and same-store sales dropped 13.1%. Management anticipates further tough times lowering fourth quarter earnings guidance down 14%.
The company’s poor performance has sucked most of the enthusiasm out of the stock with the price falling from a high of around $80 to a low around $30. Assuming annual sales of $1.26 billion and average adjusted cash earnings of $137 million with a multiplier between 12x and 14x, Deckers' reasonable fair value would be around $43 to $50 per share. If the stock continues to lose favor, it might be worth watching for an advantageous purchase.