Wicking, Tennis Shoes & Speed Bumps

This is a sample stock analysis, the type of feature that we regularly share with subscribers at http://www.manifestinvesting.com  Stocks selected during our FREE/public monthly webcasts known as our Round Table have outperformed the market (Wilshire 5000) for over 5 years.  FREE test drives and trial subscriptions available.

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Under Armour (UAA)

Subscribers may remember our explorations and discussions inspired by Charles Carlson about the avoidance of being “stubborn” in investing. (See Rules of Engagement , December 2008) His Rule #8 was “Have the Courage to Act on Your Conviction, BUT, Do Not Confuse Conviction with Stubbornness.” We might also remind ourselves about the conviction displayed by David Gardner and his exemplary performance for the Motley Fool Stock Advisor newsletter. (First Break The Rules , April 2016) His mettle was definitely tested with Amazon, Netflix and others while remaining steadfast on the path to exceptional returns. Which brings us to one of the Motley Fool Faves … and our May 2016 selection of Under Armour.

Under Armour was selected for this feature nearly a year ago. The stock price has dropped approximately 42% since then — while the general market has been “en fuego.”

Apparel retail is never easy. Entering the competitive fray with the likes of Nike and Adidas to deliver shoes could definitely be characterized as kicking sand on an 800-lb gorilla or two.

On top of that, a confusing whirlwind of ticker changes and voting rights “innovation” lead to a confusing and uncertain impression that scatters the institutional investors like screaming “Fire!” in a movie theater.

The ultimate result is the price swoon shown in the accompanying figure.

Growth, Profitability, Valuation

The Manifest Investing sales growth forecast for UAA is 11.2%. Value Line has a 3-5 year sales growth forecast of 24%. Morningstar sees growth in the 11-12% for 2017, a “sharp deceleration” from 22% in 2016. S&P still sees 18% earnings growth going forward.

We’re using 6.7% for the projected net margin. The average net margin has been 6.3% for the period 2009-2016. Value Line has a 3-5 year projected net margin of 12.7%. Under Armour is clearly in the throes of a life cycle profitability speed bump.

The median P/E for the period 2009-2017 is 43.2×. Value Line has a projected average P/E of 35.0×. We’re using approximately 30x for the projected average P/E.

At the time of selection (2/7/2017), the stock price is $20.47, the projected annual return is 11-12%. The quality RANKING is 95 (Excellent) and the financial strength rating is 91 (A+).

Points of View

On 1/31/2017, Value Line reduced expectations for revenue growth and EPS for 2017. The company also announced the departure of the CFO — another log on the uncertainty fire when it comes to the institutions. Value Line continues to advise “all but the most aggressive investors to look elsewhere … for a company already facing multiple headwinds.”

We mentioned David Gardner and his loyalty to some of his more turbulent selections over the years. As we noted in the article, many of his best performers encountered extreme speed bumps. And it was his brother, Tom Gardner, who selected Under Armour on 9/20/2013 at $19.47.

Our experience has been that speed bumps are inevitable during the life of all companies, even the bluest chips. One often occurs after the expiration of the IPO restricted period. A second often occurs after emerging into consistent positive profitability and I think we’re seeing this here. We’ll take a look at a 45-year analysis of Nike to illustrate and make mettle testing manifest.

A Few Moments With Life Cycles, Courtesy of Nike (NKE)

I’m not sure why I hadn’t done this yet. We did take a 20-year look at CSX (CSX) a while ago to examine long cycles. But this is for a different reason. I remember a 30-year Stock Selection Guide article that was contributed to the Better Investing BITS newsletter by Diane Graese many years ago. In the article, Diane shared a very long term perspective on Dana Corporation, complete with all of its cyclical warts and wrinkles. It’s time to go back.

You can’t do this (meaningfully and with as much relevance) for companies that have a lot of M&A activity in their history.

But in this case, Nike is relatively clean in this regard. Although it has evolved, Nike has been basically the same company with a fairly steady capital structure and product portfolio for many years.

Nike (NKE): Business Model Analysis (1984-2020). Sales growth has been fairly steady for an apparel retailer over the years, checking in at low double digits since inception. The sales growth trend and forecast for 2004-2018 is closer to 8%. The emergent EPS point is clearly shown for the company in the mid-1980s. Stock price? Stock price follows earnings. Rinse. Repeat. Nike shareholders are smiling and wouldn’t be surprised to be owned by Berkshire Hathaway some time soon with a chart like this.

Nike (NKE): Profitability as measured by Net Margin (1984-2020). This is a powerful long term trend. The moment that we notice — that I believe has context with respect to Under Armour — is the 1998 downdraft in profitability. Global recessionary pressures at the time, in combination with diminishing returns from Peak Air Jordan, came together in a perfect storm that resulted in some optimization, investment in infrastructure and product portfolio shuffling. The result was a “speed bump” in earnings that impacted stock price and generated something of a stock price plateau for a few years. But persistent year-after-year gains in profitability and earnings wears down the most steadfast rhino over time. This chart, as part of our Management Report Card for any company, is exemplary when it comes to Nike.

Nike (NKE): Valuation (1984-2020). The P/E ratio languished during the early years (1984-1988) until the EPS stabilized “north” of 0%. Nike never saw the types of P/E ratios that a company like Under Armour has exhibited — but a P/E ratio in the high teens is fairly easily defended. The P/E ratio trend will often track on a trajectory similar to the profitability and that seems to be the case with Nike.

Update on Under Armour

Under Armour (UAA): Update. Growth expectations have been slashed for 2017 and perhaps, 2018. The impact on 2017, 2018 and the 3-5 year forecast has been reflected here.

Bottom line? I really do believe that Under Armour is going through the same type of speed bump experienced by Nike at the 10-15 year mark. Kevin Plank has aggressively grown the company, the products are outstanding and the customers are loyal.

Under the reduced expectations discussed by Value Line (1/31/2017) the return forecast is now low double digits. But with the average stock at 5-6% and the prospect (long term) of beating the sales and profitability expectations — even while the average P/E ratio moderates — this could be rewarding for the most adventuresome out there with appropriate time horizons.

Dogs of the Dow: Howling Again?

Might The Dogs of the Dow Be Howling Again?

The Dogs of the Dow is a relatively passive (one year updates) strategy credited to Michael O’Higgins back in 1991. But it was not a new concept with Finance Journal articles dating back to 1951. It was simplistically based on the current yields of the Dow 30 stocks. The Motley Fool also featured a “Foolish Four” based on similar concepts but that has faded from attention over the years. The strategy was also compromised by the addition of non-dividend stocks to the Dow several years ago.

What happens if we utilize total return forecasts (instead of current yield) to go shopping among the Dow stocks?

2015 Results and Long Term Performance

In 2015, the ten companies selected as Dow Dogs delivered a total return of 2.6% vs. 1.3% for the S&P 500. The returns since 1999 are shown in the accompanying table — with the Dogs outpacing the S&P 500, 7.9%-to-5.7%.

Source: www.dogsofthedow.com

What about a little more history? Mark Hulbert documented the 50 year period leading up to 1999 in his article, However You Train It, That Dog Won’t Hunt: “Consider the many attempts to improve on the “Dogs of the Dow” strategy, which recommends buying, on Jan. 1 of each year, the 10 highest-yielding stocks among the 30 in the Dow Jones industrial average. The strategy has beaten the Dow by about three percentage points a year, on average, over the last 50 years…”

All of the documentation goes on to share stories of attempts to improve on the strategy, etc. over the years. Moments with Loeb and Rukeyser suggest that if the strategy becomes too popular and “deployed” that performance failure becomes a self-fulfilling prophecy.

I have a simple question. What’s wrong with beating the market by a couple of percentage points over the long term?

Beyond Dividends to Returns

First, we don’t believe that a 1-year forecast for any single stock can be done without a pretty broad dispersion of results. The correlation for the Dow 30 in 2015 was typical. It’s not very correlated.

Second, we do believe that results get better when measured by portfolio or dashboard. There’s strength (and error cancellation) in numbers …even relatively small numbers.

The accompanying chart displays the forecast return via analyst consensus estimates, ACE on the x-axis versus the actual results on the y-axis for the Dow 30 stocks from January 2015.

Our attention is drawn to the five highest return forecasts — those on the right of the diagram. One year ago, those five stocks were: General Electric (GE), JP Morgan (JPM), Johnson & Johnson (JNJ), Microsoft (MSFT) and NIKE (NKE).

The average 1-year total return for these five stocks was 18.2%.

The average 1-year total return for the five stocks with the weakest return forecasts one year ago checked in at 1.8%.

A New Iditarod? Gone Shopping For Best In Show

The stock prices and ACE-based 1-year total return forecasts in the accompanying chart are from 12/31/2015.

Yes, they’ve changed a little with the zany market gyrations of the last three weeks.

But for 2016, we’ll go with the following five selections as our Dogs based on total return forecast:

  • Pfizer (PFE)
  • United Health Group (UNH)
  • Merck (MRK)
  • Cisco Systems (CSCO)
  • NIKE (NKE)

The “Diamonds” of the Dow 30 have a lot going for them. The long-term return forecast (1/22/2016) is 8.8%. Most of the companies are mature, blue chip stalwarts with an average quality ranking of 87 (Excellent). With maturity comes reduced expectations for overall growth — and the average sales growth forecast is a modest 5.0% for the Diamonds. This means that if you were to use this for part of your personal (or club) portfolios, you’d want to spend time discovering and owning some of the best small companies to bring some faster growing components to the overall portfolio.

Dow Diamonds: Chronicle. Time series display of return forecast (PAR), quality ranking and ETF (DIA) price over the last few years. Quality has been steady. The summer/autumn of 2015 price dip may have suggested a multi-year buying opportunity (relatively high return forecast) at the time.

Price Performance: DIA. Chart courtesy of www.stockcharts.com This 20-year perspective on the Dow 30 stocks underscores the reality is that even blue chips come with speed bumps and plateaus. The 18-year annualized total return for the DIA exchange traded fund is 5.8%. Yes, Virginia. That lost decade was a beast. RSI: For more on meaning/understanding, see: Relative Strength Index ROC: Annual rate of change. See: ROC.

Conclusions and Updates

If you were starting your Dogs portfolio today, the five stocks would be different (CSCO, BA, DD, PFE and GS). The 2016 market for the last three weeks has pummeled the stock prices of many of these companies and the overall 1-year return forecast for the DIA has increased from 12.1% to 21.7%.

The analyst consensus is the market is undervalued as suggested by ACE and the 1-year total return forecasts from S&P and the influential research giants like Goldman.

S&P is not as enthusiastic about the long-term values (P/FV=100%) versus Morningstar (P/FV=87%). The Value Line 3-5 year total return forecast is 8.3%.

The average return for the Top Five was 18.2% versus 1.8% for the Bottom Five. We’ll track this going forward and check back to see how the 2016 stocks check in on December 31, 2016. For now, that’s an interesting difference and — in my opinion — collectively supports/affirms our analysis methods and gives us a nudge to study and own some of these blue chippers for as long as it makes sense to do so.

Dow Jones 30 Industrials: The Long & Short. (January 21, 2016) Projected Annual Return (PAR): Long term return forecast based on fundamental analysis and five year time horizon. Quality Ranking: Percentile ranking of composite that includes financial strength, earnings stability and relative growth & profitability. VL Low Total Return (VLLTR): Low total return forecast based on 3-5 year price targets via Value Line Investment Survey. Morningstar P/FV: Ratio of current price to fundamentally-based fair value via www.morningstar.com S&P P/FV: Current price-to-fair value ratio via Standard & Poor’s. 1-Year ACE Outlook: Total return forecast based on analyst consensus estimates for 1-year target price combined with current yield. The data is ranked (descending order) based on this criterion. 1-Year S&P Outlook: 1-year total return forecast based on S&P 1-year price target. 1-Yr “GS” Outlook: 1-year total return forecast based on most recent price target issued by Goldman Sachs, Merrill Lynch, JP Morgan Chase or Morgan Stanley.

Note: The price targets from Goldman Sachs (“GS”) are from public releases and represent a partial sample. The price target is logged as of the most recent public analyst report. Although every effort is made to keep this information as current as possible, some of the ratings may not reflect more recent research and updates. Some of the older Goldman Sachs estimates (>6-9 months) have been adjusted using more recent price targets from Merrill Lynch, JP Morgan, Morgan Stanley etc.

Dogs of the Dow: Arbitrage Hedge Demonstration

It bears repeating.

For the year ended 12/31/2015, the Top Five stocks using our Dogs of the Dow approach based on total return delivered a collective performance of 18.2%. The Bottom Five checked in at 1.8%.

This is a candidate for an arbitrage strategy. For more, here’s the Wikipedia version.

We’ll play along with the following dashboard during 2016. We’ll assume that some investing firm (think hedge fund) will allow us to short the Bottom Five by selling $200,000 worth of each stock on 12/31/2015. Simultaneously, we’ll take the proceeds from those five transactions ($1,000,000) and spread that among the Top Five.

The current results through 1/22/2016 are shown in the accompanying chart.

Dogs hedge 20160122r