Expectations are everything for a growth stock. Especially one with massive growth like Under Armour (UA, Financial).
From a fundamental standpoint, this growth is warranted. Even the latest third quarter earnings looked solid. Under Armour reported another revenue increase of 22%, which is its 25th straight earnings report of revenue growth of at least 20%. Total revenue came in at $1.47 billion, beating expectations of $1.45 billion. And earnings also beat expectations of 25 cents a share, coming in at 29 cents a share.
Under Armour was able to double their share of the footwear market during this recent back-to-school period, shooting up to 8.2% market share from 4.6% a year ago. Total apparel sales increased 18% to $1.02 billion for the quarter while footwear sales increased 42% to $278.8 million. The company even made strides in its online presence, growing direct-to-consumer sales 29% from a year earlier. This was helped by the three new e-commerce websites they launched during the quarter.
But even with this stellar earnings report, the stock’s price dropped over 13%. And that’s because investors were only focused on the fact that growth expectations were lowered going forward. The company explained:
“While we expect to continue to significantly outpace the apparel industry, the growth rate going forward will be less than expected from our Investor Day in 2015.”
The company said it expected its revenue to grow in the low 20% range during 2017 and 2018, which while by itself is still impressive, would be Under Armour’s worst performance since 2009. They also warned that profits and margins would shrink as the company reinvests to attack new pockets of growth overseas and also new segments like footwear to make up for the difficult retail environment in North America. Gross margins were already squeezed this quarter, dropping from 48.8% a year ago to 47.5%, mostly due to increased discounts and promotions.
All in all, the earnings report was solid. But it wasn’t perfect. And you need perfect when you are a growth stock.
If you take a look back at Under Armour’s price chart you see a nearly parabolic price series. This is what happens with growth stocks. Investors have a certain set of expectations, the company exceeds them, the price soars. The next round investors increase their expectations higher, the company beats again, and the stock flies even higher. This process repeats in a Soros-style reflexive loop until price diverges too far from reality.
At this point you can expect that the company will fail to meet expectations. And that’s exactly what began to happen to Under Armour in late September of last year. Growth concerns started to mount and the stock price began to decline. When this happens you can expect a large correction as the stock price readjusts to the new investor expectations.
The correction started in September 2015 and Under Armour put in an intermediate low on Jan. 21 of this year. But as you can see below, today’s move has broken that low, completing a large descending triangle formation.
This is what we like to call an inflection point. You get a fundamental piece of news, which price has a heavy reaction to. It is a signal that a new trend is being formed and that now is the right time to jump in. This is one of the best ways to combine technicals and fundamentals to increase the probability of a successful investment. Should price hold below the levels of the lower descending triangle boundary into the end of the week, we will consider putting on a short position.
We call this the nail in the coffin because this is the significant break we look for in growth stocks. Price pattern completions confirms that investors’ fundamental expectations have been permanently changed, and now we expect to see an equally large adjustment in price.
Under Armour is still a good long-term play, but it would be unwise to hold through this coming correction. And if you are looking to establish a long-term position, allow price to get back to reasonable levels before doing so. You will get a much better price if you decide to wait.
Disclosure: We currently hold no position in UA.
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