Based on all of my usual criteria, I should be writing a piece today that suggests selling Under Armour (UA). Even before this morning’s jump in the price to new record highs, the valuation of the sportswear company looked “substantially stretched,” as the Fed might say. Even digging deep into a great earnings release this morning it is possible to find negatives. There are countless reasons to believe that the stock is heading for a fall, but one factor, to me, overrides them all:
We've been here before.
Under Armour has, over the last couple of years, never looked cheap by any conventional valuation metric. Currently, Price to Earnings Ratios (P/Es) of around 80 (trailing, based on last year’s earnings) and over 50 (forward, based on estimates for next year’s earnings) hardly suggest screaming value. The situation doesn’t look any better when growth is factored in either. A PEG ratio of less than 1.0 is generally accepted as indicating that a stock is cheap, so Under Armour’s 2.78 PEG suggests that future growth is well and truly priced in. If you think this may be just the industry, then consider that the equivalent numbers for Nike (NKE) are P/Es of 26.42 (trailing) and 19.79 (forward) and a PEG ratio of 1.70.
The thing is though that, like many real growth stocks, UA has looked expensive based on P/E and PEG for a long time but has continued to rise.
Under Armour (UA)
In the spring of this year, when the so called “momentum” stocks were punished, Under Armour was hit hard, but the stock’s performance at that time showed that irrational selling can be just as stupid as irrational buying. On April 24th, the company reported earnings and revenues that beat expectations, higher guidance for the rest of the year and improved margins. The stock dropped over 8 percent that day and continued to fall for another couple of weeks.
This morning they reported another beat, with EPS coming in at $0.08 versus estimates of $0.07 and revenue of $609.65 million versus the $574.37 million that the street was looking for. Once again, guidance was also raised. This time, in a kind of “once bitten, twice shy” reaction, the stock is soaring, up over 8 percent in pre-market trading to new all time highs. These differing reactions to similar reports should convince you of something that I have often said; the biggest short term driver of a stock’s price is market sentiment and positioning rather than fundamental factors.
Of course, over time, profitability is what counts. That is why I said earlier that this generally great quarterly report from Under Armour could be taken as a negative. Revenues increased more than profit and that continues a trend. As the company grows you would expect margins to improve significantly but that turnaround still appears to be some way off. An overall 6.72 percent margin is low, even in the industry. Nike, for example manages a 9.69 percent margin.
When it is laid out like this, it is hard to make a logical, fundamental case for UA, but for one thing. The company has a history of making even inflated looking expectations seem too conservative. They deliver exponential sales increases year after year. Sometimes, you have to remember that value, like beauty, is in the eye of the beholder and despite numbers that suggest that UA is overbought, that history of growth makes it look cheap to many.
Based on the admittedly small, unrepresentative sample of my 12 year old son and 11 year old daughter and their friends, that situation is set to continue. They are fans of the brand and will gladly pay more for the UA logo. In case you think that is an easy decision when it is my money, I should point out that I am attempting to educate my kids as to value by finding a cheaper option then demanding that they pay the difference. The fact that they will still pay a premium for Under Armour products indicates either the strength of the brand or my weakness as a teacher. I prefer the former explanation.
I, like most people who trade or invest, can often get too caught up in my own “system.” The Under Armour story is a reminder that not all companies can be judged using the same parameters. Sometimes we have to look at different criteria to understand long term moves in a particular stock. In the case of UA it is their ability to sustain trendiness over time that is the seemingly illogical X factor. Neither anecdotal nor numerical evidence suggest that that situation is changing, and as long as it continues the stock can continue to rise, regardless of valuation.