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The Science of Hitting
The Science of Hitting
Articles (489) 

Why I'm Trimming My Under Armour Position

Some thoughts on my investment in UA

I’ve written a number of articles about Under Armour Inc. (NYSE:UA) (NYSE:UAA) over the past 12 to 18 months (here’s the main one). I don’t want to beat a dead horse, but I like to share my thoughts when I make changes in my portfolio. The reason I do so is because I like the feedback (and pushback) that I get from readers. As always, you should do your own research and come to your own conclusions.

With that, I would like to outline the rationale for trimming my stake in Under Armour.

Valuation

The first point is the most important one. Since the end of last year, Under Armour shares have had a good run. When the stock was at $12 per share, I was comfortable with the assumptions I needed to make to justify owning the stock in size. At those levels, I thought the risk-reward tradeoff was out of whack. But with the stock now north of $21 per share, I’m less comfortable saying that.

My read on the recent financial results is Under Armour still faces some notable short-term headwinds. The company’s direct to consumer and international businesses continue to grow at an impressive pace, but they are still relatively small. For now, trends in the North America wholesale business are still quite important for Under Armour. That’s a long way of saying my fair value estimate and my thoughts on the company have not meaningfully changed from where they were a few quarters ago.

What has changed over that period is the stock price. When Under Armour kept making new lows and reached a level around 10 times pretax normalized earnings, I thought it was time to buy. Now that the stock has risen pretty significantly, I think it makes sense to cut back a bit. Under Armour has become relatively less attractive as it has moved higher over the past six months.

Position sizing

This point ties into the first one. As I noted in my 2017 year-end portfolio review, I bought a fairly significantly amount of Under Armour near the end of last year. As I made clear at that time, and as is the case with every investment I make, I had absolutely no idea what the business or the stock would do over the short term. I certainly didn’t expect it to move significantly higher over the next six months (said differently, I got lucky).

At year-end, the Under Armour position accounted for a mid-single-digit percentage of my portfolio (and a much higher percentage of the equity bucket). With the stock moving higher in 2018 and without any selling along the way, I was left with a position that accounted for more than 10% of my portfolio. As a result, Under Armour recently passed names like 21st Century Fox (NASDAQ:FOX) (NASDAQ:FOXA), Comcast (NASDAQ:CMCSA) and Microsoft (NASDAQ:MSFT) to become my second-largest holding.

In recent weeks, I have found myself thinking about Under Armour’s stock price. My sense is that I’ve been thinking about it a bit too much. When I start focusing on short-term price movements, it is usually a sign that something needs to change. I think the reality is I am not comfortable with the position size north of 10%, particularly in light of what I said above about valuation.

Tax considerations

When I invested in Under Armour, I had enough cash on the sidelines to put the entire position in my individual retirement account. As a result, there are not any tax implications associated with selling a few shares. That’s an important consideration, particularly when you’re dealing with short-term capital gains. The tax tail shouldn’t wag the investing dog, but it would be just as foolish to go to the other extreme and completely disregard tax implications. If I had to send a portion of my gains to Uncle Sam, I’m not sure I would’ve made this decision. In this situation, holding the shares in my IRA allowed me to be more active than I would’ve been if the shares were held in a taxable account.

Conclusion

Under Armour’s market cap is roughly $9.4 billion. On expected 2018 revenues of roughly $5.1 billion and assuming normalized pretax margins of roughly 10%, the stock trades at about 18 times pretax earnings. If the long-term effective tax rate is near the fiscal 2018 number (mid-20s), the normalized price-earnings ratio is on the order of 25 times earnings. Based on reasonable growth expectations and a discount rate of roughly 10%, I’m getting to a comparable terminal multiple when I look out a few years.

Does that number (25 times) makes sense in light of the company’s long-term growth prospects? Maybe. But it’s also off of a normalized earnings per share estimate, which doesn’t hold as much weight in my mind as actual results (said differently, it is way too optimistic if Under Armour can’t deliver). I’m also thinking about this in relation to the Bill Nygren (Trades, Portfolio) quote I shared in a recent article:

For almost all businesses, our crystal ball goes dark after seven years, so we assume all businesses trade at similar P/E’s after seven years. With an estimate of fair value seven years in the future, we can discount that back at an appropriate risk-adjusted discount rate to estimate today's value. Whether that results in a near infinite or a negative P/E on current earnings is not of concern to us.”

Even though I don't buy in entirely, I think there’s merit in that approach. It may lead to being a bit too conservative, particularly on businesses where outsized growth and / or above-average business quality seem highly likely beyond the forecast period, but it also keeps you honest (predicting what will happen beyond 2025 is not an easy thing to do).

For these reasons, I think it makes sense to pull back a bit on my Under Armour position.

Disclosure: Long UA, FOX, FOXA, CMCSA and MSFT.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 5.0/5 (2 votes)

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Comments

Joshua81
Joshua81 premium member - 4 months ago

Not a bad place to take profits but I think the worst is behind this stock. However, stock prices aren't rational and fundementals change with increased sales and revenue along with managing expenses. I believe Under Armour has more room to run and will be a top performer over the next 3-5 years.

The Science of Hitting
The Science of Hitting - 4 months ago    Report SPAM

Joshua - Agreed on the next 5+ years, which is why I still continue to own a decent sized position in the stock. We'll see what the next few years bring us. Thanks for the comment!

stephenbaker
Stephenbaker - 4 months ago    Report SPAM

Science, did you acquire the position only expecting the stock to rise to $21/share? If not, why sell? In other words, if your long term thesis remains in tact, what difference does the current (temporary) stock price make? Perhaps that is where we differ - I rarely care what the stock price is other than when it drops for reasons that don't impact long term operations or performance (which presents a better buying opportunity than the original share purchase). If the price rises too fast so be it. Selling after a rapid price rise is more like trading unless you have a specific, current use of the funds which is superior to your UA investment. Personally, my stock investments are all dividend stocks (BRK is the sole exception) which somewhat reduces the urge to sell regardless of price movement. That and the lack of public companies whose management I trust for the long haul.

The Science of Hitting
The Science of Hitting - 4 months ago    Report SPAM

Stephen - That's an interesting question. If the stock was up 25% or 30%, I would agree. But I think the run we've seen since the end of 2017 has changed the expected returns pretty meaningfully. Let's say your time horizon is five years. If you think it gets to $30 (arbitrary number), starting at $12 is good for a 20% CAGR, whereas starting at $21 is good for a 7% CAGR. I still own a lot of UA - I just own a little bit less than I did because I don't think the risk/reward is as attractive as it was six months ago. With that said, I do understand what you're saying (and see its merit). As it relates to the use of the funds, I actually do think there's a good chance I'll use it in the near future. I have some ideas I'm willing to add to (and those odds improve if we see some market volatility). I don't know if that fully answers your question, but hopefully it helps! Thanks for the comment.

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