If you pay much attention to market news, most of the focus revolves around the segments of the economy that are performing the best right now. It’s a classic “follow the herd” mentality that can actually work pretty when the economy is healthy and growing, but it also has its drawbacks. It tends to keep you focusing on stocks that are consistently trading at or near all-time highs, and when the market is extremely extended – as it is now – their valuations often create more risk than their opportunity can justify. That’s because history has also shown that the herd is usually wrong about the points when the market is about to reverse and shift from bullish to bearish conditions and trends, and so at these extreme highs, the risk that you’ll be on the wrong side of the market, at the wrong time becomes incrementally higher than it is at earlier stages of a bull market’s run.
One of the ways I like to try to minimize this risk is by focusing on fundamentally strong stocks in sectors that are underperforming the rest of the market. It’s counter-intuitive to a lot of investors to avoid following the herd, and that’s why you’ll usually hear people refer to investors like me “contrarians.” That’s a badge we like to wear proudly; we find value in places the rest of the market is ignoring right now, because we know that eventually the market’s ever-shifting attention is going to gravitate back to these industries, and when that happens, the stocks with the best fundamentals are the ones that usually stand to profit the most.
The irony of my contrarian attitude is that the stock I’m writing about today, Skechers U.S.A., Inc. (SKX) is a stock in one of the best-performing sectors so far this year. As measured by the SPDR Select Consumer Discretionary ETF (XLY), the Consumer Discretionary sector is up almost 19% this year and is absolutely one of the best-performing sectors in the stock market since the beginning of 2017. SKX, in the meantime is without a doubt one of the biggest under-performers in the sector, having declined a little over 30% for the year, and more than 38% since mid-April. It’s that underperformance that piques my interest, especially since the stock actually has a strong fundamental profile, highlighted by very conservative levels of debt, healthy liquidity and improving intrinsic value. When you those elements against the stock’s poor performance over the last several months, you get a stock that is priced at incredibly attractive levels.
The economy continues to be healthy and growing, and even some of the best and brightest minds in the market expect it to continue for the next couple of years. That bodes well for the market in general, and for the Discretionary sector in particular, and that means that looking for stocks like SKX that are actually significantly undervalued compared to their industry and sector peers could offer the best, high-probability investments right now.
Fundamental and Value Profile
Skechers U.S.A., Inc. is a designer and marketer of Skechers-branded lifestyle footwear for men, women and children, and performance footwear for men and women under the Skechers Performance brand name. It also offers apparel, accessories, eyewear, scrubs and other merchandise. It sells its footwear in department, specialty and independent stores, as well as through its Skechers retail stores and online at skechers.com. The Company operates through three segments: domestic wholesale sales, international wholesale sales, and retail sales, which includes e-commerce sales. Its lifestyle brands include Skechers USA, Skechers Sport, and Skechers Active and Skechers Sport Active. Its Performance Brands include Skechers Performance, Skechers Kids and Skechers Work. As of December 31, 2017, the Company’s products are available in over 170 countries and territories through its network of subsidiaries in Asia, Europe, Canada, Central America and South America. SKX’s current market cap is $3.6 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings declined by a little over 23.5% while revenues posted an increase of about 10.6%. In the last quarter, earnings declined even more, at -61%, while sales also declined by 9.2%. The company also operates with a narrow margin profile, with Net Income running at only about 4.2% of Revenues for the last twelve months, and 3.9% in the last quarter. These elements, which by themselves could be taken as red flags, appear to be the primary drivers in the stock’s underperformance through the year.
- Free Cash Flow: SKX’s free cash flow is healthy, at a bit over $185 million. Free cash flow has also seen a big increase since the beginning of the year, when it was only about $25 million. That is an interesting, and in my opinion important counter to the pattern of declining earnings I just referred to. Free Cash Flow is a harder number to manipulate for earnings reports, and for a lot of investors, including myself, is a more accurate representation of a company’s profitability than earnings per share.
- Debt to Equity: SKX has a debt/equity ratio of .03. This number reflects the company’s very low debt levels, which were only $70 as of the most recent quarter. By contrast, the company held more than $887 million in cash and liquid assets at the end of the quarter, emphasizing their solid financial base and excellent liquidity.
- Dividend: SKX does not pay a dividend at this time.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for SKX is $13.52 per share and translates to a Price/Book ratio of 1.95 at the stock’s current price. Their historical average Price/Book ratio is 2.72. That suggests the stock is trading right now at a discount of about 39%, which puts the stock’s long-term target above $36 per share. Additionally, the stock is currently trading more than 63% below its historical Price/Cash Flow ratio, which translates to a target price at around $43. No matter which target you prefer to work with, SKX looks like a stock that offers an excellent bargain opportunity.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from mid-April to its bottom in July of this year; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock rallied high from trend low support at around $24 per share to a short-term peak at about $30 in late August, but more recently has retraced pretty sharply. That pivot high in the $30 range, along with the 38.2% retracement line at around $31, are likely to offer pretty significant resistance in the near term. A break above $31 will be required for the stock to begin to stage any kind of sustainable intermediate or long-term upward trend.
- Near-term Keys: If you’re a short-term trader looking for a good opportunity with this stock, you’re going to have to be patient. Trying to play the bullish side right now, given the stock’s current bearish momentum is pure speculation, with an extremely low probability of success. The problem with trying to follow that bearish momentum right now, however is that the stock is only a couple of dollars away from it’s 52-week low, and a point that has seen the stock find major support multiple times over the past year. The stock would have to drop below $24, to about $23 before you should take any kind of bearish play, either by shorting the stock or working with put options seriously, and it would need to break above $31 for a high-probability bullish trade from buying the stock or working with call options. A bullish reversal off of support at around $24 could offer a reasonable short-term bullish trade if you use $29 – $31 as a target range. If you like the stock’s long-term value proposition, and you’re willing to ride out some likely price volatility for the foreseeable future, however, the stock’s current price offers an incredible discount right now.