I always try to warn investors about momentum stocks with high valuation ratios.
One never knows when the momentum will change, and when it does, it can come quickly.
When the change occurs, it may be an opportunity for real investors to step in and buy a small piece of a good company at a great price.
This happened last week to a company I remember seeing late last summer trading about $80 a share, and realizing this retailer was trading around 25 to 30 times forward earnings.
All the hype was there about how great sales were going and how this retailer was growing at a fantastic rate.
The company that I am talking about is the well-known retailer Michael Kors Holdings Ltd. (NYSE: KORS). The company owns 176 stores and has 176 licensing partners that also operate stores.
By licensing to third parties, Michael Kors products are found in many countries around the world — Korea, Australia, the Middle East and China, just to name a few.
While many people think Michael Kors is a relatively new company, it’s actually been around for 34 years.
The stock has a 52-week high of $97.14, which was reached about one year ago. Since that time, it has steadily declined.
Last week’s earnings report missed by one penny, sending the stock down nearly 20 percent in one day.
Now keep in mind the company did not lose money; it didn’t even decline in year-over-year sales. The reason for the big decline stems from the company experiencing a slowdown in the growth of earnings and sales.
So has this company now become a good value? Let's look at some of the fundamentals with the stock cut in half.
Looking at what investors now pay for the earnings based on the trailing 12 months' earnings, the price-to-earnings ratio is now only 11.0, well below the industry average of 28.6. Price-to-sales is still more expensive for the company at 2.2, which is higher than the industry at 1.8.
Making this a value buy is what investors pay for the tangible book value of this company of 4.5, well below the industry average of 23.9. Price-to-cash flow is 9.4 for the company, roughly half the industry average at 20.2.
Thinking back to when the stock was at $98 a share, I'm sure that all these valuation ratios were more than twice what they are now for the company — which should have warned investors to stay away and be patient.
I'm sure going forward the sales growth for the company will probably be cut at least in half; moreover I understand over the past 12 months, sales grew at nearly 41 percent.
If they could grow sales at even a 10-percent rate, I would be thrilled, especially when you compare it to the industry average growth of 5.5 percent year over year for the past 12 months.
It is nice to see a company that can grow its sales at 41 percent and earnings per share grow at the same rate, in this case, 42 percent.
Comparing the 42 percent growth on earnings to the industry average decline of 2.6 percent should make investors smile.
When looking at investing in a company where the stock has been cut in half, an investor should look for some safety by verifying the company has a strong balance sheet. That is the case with Michael Kors Holding Ltd.
The current ratio stands at 5.5 for the company, more than double the industry average of 2.4. A current ratio that high gives me a very good feeling, based on the company's liquidity.
To make things even better, when I looked at the debt to equity for this company, I discovered they have zero debt on the balance sheet, compared to the industry average of 51 percent.
Nothing makes me happier than a company with no debt, a lot of liquidity, and growing earnings in the past and future.
Also important is the return on equity of a company. The industry average for companies like this is 14.2 percent. Compare that to the company at a rewarding 45.5 percent.
It's nice to have a company that everyone likes and can make a good profit on sales. Kors has a net profit margin of 20.4 percent, more than three times the history average of 6.2 percent.
I also like the efficiency of the receivable turnover coming in at 13.6, versus the industry average of 8.9 over the past 12 months. Also impressive is the inventory turnover at 3.4 times, which beats the industry average of 6.2 over the past 12 months.
The company reports its yearly sales on a fiscal year, so we now get to go out to the year ending March 2017. The mean estimate of 17 analysts is looking for earnings per share of $4.93, with the high estimate at $5.75 and the low estimate at $3.36.
Now while I understand these estimates could come down in the next week or so, looking at the analyst with the lowest estimate of $3.36 for the year ending March 2017 and using a PE ratio of 16.5 would yield a stock price of $55.44 — a gain of more than 20 percent.
Using the average estimate of $4.93 gives a target sell price of $81.35. What this means is the gain could be as high as 75 percent, based on a 16.5 multiple.
The price-to-earnings growth, also known as the peg ratio, is 1.02 on the short term and 0.41 on the long term.
It's important for investors to be cautious in this market and time of year when investing, but sometimes a good opportunity comes along. You just have to ask where this business will be in the next 12 to 24 months, not what will happen this summer to the stock price.
I think Michael Kors Holdings Ltd. is worth a look in one’s portfolio.