One of the toughest parts of investing is knowing when to sell your winners, especially ones that have delivered exceptionally large gains in a relatively short time. The thing about stocks that go up fast is they can go down even faster, quickly wiping out your profits -- and then some.
This may be exactly where one well-known stock is headed because it, too, has risen fast, about 135% in the past year and a half or so.
But that's not the only reason it could drop. Just because a stock is way up doesn't necessarily mean it's poised to pull back.
No, there are specific reasons to be leery of this firm, a relatively small but popular upscale footwear and accessories maker best known for its Ugg brand of boots, shoes, sneakers and other products. I see the company as something of an upstart because even though it has minuscule sales relative to its biggest competitors, such as Nike (NYSE:NKE) and Adidas (OTC: ADDYY), it clearly has had its share of success in the past.
Indeed, Deckers Outdoor Corp. (NYSE:DECK) has more than doubled annual sales to $1.6 billion from $689 million in 2008. During the same period, earnings per share (EPS) have more than doubled, too, from $1.87 a share to $4.08.
So what's the problem? Well, the very thing that has made Deckers a success is exactly what could bring down its stock.
Deckers is far too reliant on Ugg, which accounts for 83% of sales, and this lack of brand diversity has come home to roost before. After reaching a peak of nearly $118 in the fourth quarter of 2011, shares of Deckers retreated horribly, losing 75% of their value over the next 12 months and plunging to a multi-year low of about $29.
The stock fell more than 20% alone between Oct. 19 and Oct. 26 of 2012, right around the time Deckers reported a 12% decline in Ugg revenues for that year's third quarter. Falling sales from Ugg was the main reason earnings dropped 31% that quarter and 32% overall in 2012. At the time, analysts were saying the brand had begun to go out of style.
In the fickle world of Wall Street, all this was more than enough to crush Decker's stock.
In response, the firm cut prices to stimulate Ugg sales and began using cheaper raw materials to try to minimize margin compression. As a result, the bottom line rebounded 21% in 2013, and Deckers posted a much smaller loss than expected in the first quarter of this year -- hence the 135% gain in its stock since the fourth quarter of 2012.
Although the improvements in Deckers' bottom line and stock price are promising, they may well only be temporary. I suspect the analysts were correct about Ugg going out of style, and several indicators support this.
One is slowing sales.
From 2008 through 2011, Decker's overall sales grew a superb 26% annually. But since then, growth has only averaged 5.6% a year, and total sales are on pace to rise about 4% in 2014. But we're basically talking about Ugg here since the brand generates almost all of Decker's revenue.
With by far its largest revenue source clearly struggling, Deckers has had to spend more to get people to buy it, both indirectly through price concessions and directly through larger sales and marketing outlays. The rising cost of sheepskin and other components of Ugg products certainly haven't helped matters, either.
In the past couple years, operating costs have ballooned to 35% of sales from 27% in 2008, which in turn has hurt margins. After averaging about 22% from 2008 to 2011, for instance, operating margins have fallen to barely 13% during the past 12 months. Net margins are also way down -- to about 9% from an average of 14% from 2008 to 2011.
Even the great long-term bottom-line growth I mentioned earlier loses its luster when broken down this way. Whereas earnings per share (EPS) rose an astounding 39% a year from 2008 through 2011, they've actually contracted more than 8% annually since then.
So I have serious doubts Deckers that can achieve analyst projections for EPS growth of 11% a year for the next five years. Perhaps the analysts think this is feasible because of the firm's growth plans, which include things like increasing the retail store base to complement sales through other retailers and online, expanding in Asia and other emerging markets, and building up the other company footwear brands Teva and Sanuk.
While such initiatives could enhance profits and help diversify Deckers, they'll take years to implement, and there's certainly no guarantee of success. So even if Deckers does meet analysts' expectations, the projected growth rate in EPS is still only half that of the previous five years and only implies about 50% upside for the firm's stock to mid-2019.
That's much too modest considering the stock's high risk and uncertain future.
Risks to Consider: If Ugg truly is going out of style, Deckers may not even come close to achieving Wall Street's already mediocre growth projections. In that case, the company's stock could take a massive tumble like the one it suffered in 2012.
Action to Take --> Footwear industry upstart Deckers Outdoor has made shareholders some nice money, but the company's dubious future rests mainly on a single brand that appears to be on its way out. Decker's stock is only appropriate for speculative investors with high risk tolerance, and those who've benefited from the recent surge should consider taking profits.