In a February 9 article, The Motley Fool called headphone maker Skullcandy (Nasdaq:SKUL), one of the market's most hated stocks. Citing facts like 66% of its tradable float being short and a competitive advantage that is nearly non-existent, the analysts heaped piles of scorn on the colorful brand. I'm here to defend the tiny company providing several reasons why you shouldn't sell Skullcandy short, both figuratively and literally.
Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

Competitive Advantage or Lack Thereof
The problem with this kind of analysis is that the same thing can be said about pretty much any brand, even ones as strong as Apple (Nasdaq:AAPL). Brands are funny. You can analyze them from every angle and sometimes you still don't know why consumers buy.

I personally don't get the Lululemon (Nasdaq:LULU) phenomenon, yet thousands of women (and men) do. This despite the fact at least four companies have products that should be able to compete with them: Nike (NYSE:NKE), Under Armour (NYSE:UA), VF Corp. (NYSE:VFC) and the Gap (NYSE:GPS).

To blithely trot out products like Beats by Dr. Dre or 50 Cent's Sleek as evidence it has no competitive advantage and zero barriers to entry misses the point of branding in the first place. The assumption that brand extensions into clothing and footwear have somehow led the company down the garden path to destruction is absurd. Go to their website and you will see it has partnered with brands like Rip Curl and DC Shoes in addition to its own products.

Its headphones might not be anywhere near Dolby Labs (Nasdaq:DLB) quality, but that doesn't mean its customers aren't happy with their headphones or the brand. To dismiss its competitive advantage simply because it has some competition implies that investors should also dismiss Apple's perceived superiority, knowing that Samsung and many others are nipping at its heels. It's nonsensical.


Expansion
A look through its third quarter 10-Q provides some very telling information. International net sales in Q3 were $14.6 million, an increase of 75.9% over the same quarter in 2010, which represents 24.1% of overall revenue for Q3. Most of the increase came from Europe, where in August it acquired its exclusive distributor for $18.6 million. Rule number one when building a strong international brand is to control your distribution as best you can, and now it does.

Revenue growth in the U.S. was a more modest 37.2%, which is still well into double digits and more than enough. Online sales in the third quarter increased 416.7% to $6.2 million. Excluding the $2.9 million in online sales from its $10.8 million acquisition of Astro Gaming, organic online sales actually increased 175% year-over-year. For those of you who follow bricks-and-clicks retail, you are probably fully aware of the profitability of online retail.



As of the first nine months of the year ended September 30, Skullcandy's online sales were 9.1% of total revenue. Every 100 basis point improvement in this number is worth at least a 70 basis point improvement in overall operating profits. For example, Skullcandy expects 2011 revenues of $231 million. At 9.1% of total revenues, online sales will be $21 million with an estimated operating profit of $6.3 million out of a total of approximately $34.7 million for the entire company.

However, if its online sales are 10.1% of overall revenue, its operating profit from online sales is $7.0 million out of a total of $35.4 million or 70 basis points higher without adding a single dollar of new revenue. The shorts forget that profits don't just come through Best Buy (NYSE:BBY) and Target (NYSE:TGT).


Valuation
Skullcandy went public last July at $20. As of February 13, it was trading at $14.78. That's a P/E ratio of 15.9 based on the company's January guidance of 93 cents a share. Its net profit of $22 million is the highest in its nine-year history. Is 15.9 times earnings so ridiculous? Lululemon trades at about 58 times earnings while Nike and VF Corp. both trade at 23 times earnings. But they're apparel brands, the shorts will protest.

A fairer comparison is Apple at 14.8 times earnings they'll argue. But I'd counter this simply makes an argument for Apple longs and not the other way around. The fact remains that to a certain extent, every product has some commoditization attached to it. iPad's aren't built in Paris, they're assembled by hand in China in massive Foxconn factories.

I own a Mac but I don't feel any sort of sentimentality towards it because it was built by some faceless Chinese worker thousands of miles away. No, I like my Mac because it works and the brand's cool. How's Skullcandy any different? (For related reading, see The P/E Ratio: A Good Market Timing Indicator.)


The Bottom Line
IPOs tend to be priced too high. A Canadian investment manager I'm fond of quoting believes you should never buy an IPO right out of the gate because inevitably, one or two years later, the stock is trading for less than its offering price.

He suggests you buy it then. Skullcandy is currently trading 26% below its IPO price. My advice is to buy a small position today, watching to see if it drops back to its 52-week lows as it nears its one-year anniversary in July. Despite what the shorts would have you believe, Skullcandy is doing just fine.


Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  2. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  3. Markets

    Why Gluten Free Is Now Big Business

    Is it essential to preserving your health, or just another diet fad? Either way, gluten-free foods have become big business.
  4. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  5. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  6. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  7. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  10. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!