Short-term traders love fad stocks. The public’s temporary infatuation with a hot product often causes investors to turn a blind eye to basic stock fundamentals, which often causes big rallies that can translate into big profits for traders. However, long-term investors should be wary of top-heavy fad stocks, which could unexpectedly fall off a cliff once the public tires of a product, or if it becomes commoditized through imitation.
Mention “fad” and “footwear” in the same sentence and most investors will immediately think of.
The creator of those polarizing, hole-filled Croslite (proprietary foam resin) shoes was once a Wall Street darling, peaking at nearly $70 per share in 2007. However, the financial crisis dealt Crocs, Inc. (NASDAQ:CROX) a near fatal blow that it has yet to fully recover from. Although its shares have since recovered from its crisis low of $1 per share, analysts are still divided regarding the company’s future.
Crocs, Inc. (NASDAQ:CROX)’s first quarter results, however, definitely favored the bulls. At the end of April, the company reported adjusted earnings per share of $0.35, a 12.9% increase from the prior year quarter. Revenue also climbed 14.68% to $311.7 million. Analysts had expected Crocs, Inc. (NASDAQ:CROX) to earn $0.34 per share on revenue of $305.08 million.
Crocs, Inc. (NASDAQ:CROX) attributed its strong top and bottom-line performance to strong sales of its spring and summer product lines. Since 2007, Crocs, Inc. (NASDAQ:CROX) notably diversified away from its core Crocs, Inc. (NASDAQ:CROX) line into sportier alternatives, such as sneakers, boots, beach shoes, heels and sandals, which are all created with its Croslite resin. Crocs, Inc. (NASDAQ:CROX) reported that strong growth in Asia, which accounted for 41% of the company’s 2012 revenue, will continue to boost its top line throughout 2013. By comparison, Crocs generated 44% of its 2012 sales from the Americas.
Yet Crocs’ margins slightly edged lower, with gross margin dropping from 53.3% to 53.2%. SG&A expenses (selling, general and administrative) rose 22.9% as the company spent more heavily on new store openings, marketing and promotions.
Crocs’ cyclical revenue growth, which appears to be the strongest during the summer, looks promising, but constantly rising expenses and flat margins could lead to flat or declining bottom-line growth in the near future, which generates the majority of its revenue from its popular UGG sheepskin boots, is regarded as another fad stock by many investors. The business is extremely top heavy, with 65% of its first quarter top line generated by UGG boots alone – down from 96% during the winter fourth quarter. This means that any weather impacts, such as unseasonably hot winters, will take a bite out of yearly sales. In addition, UGG boots, which originally come from Australia, have been a fashion trend since the 1990s, which means that demand could wane as new fashion trends emerge.
Regardless of these risks, Deckers Outdoor Corp (NASDAQ:DECK) managed to post decent top and bottom-line growth that topped analyst estimates. For its first quarter, Deckers Outdoor Corp (NASDAQ:DECK) squeezed out a profit of $0.03 per share, topping the consensus estimate for a loss of $0.09 per share, and exceeding the company’s own prior guidance for a loss of $0.12. While that profit was better than expected, it still represents a disappointing 85% drop from the $0.20 per share it earned in the prior year quarter.
Meanwhile, year-on-year sales rose 7.1% to $263.8 million, beating the $255 million that analysts had expected. Deckers Outdoor Corp (NASDAQ:DECK) originally anticipated flat revenue growth. Domestic sales rose 7.1% to $182.7 million while international sales grew 7.0% to $81.1 million.
UGG sales rose 7.9% to $170.6 million. Sales of its Teva water shoes, sandals and hiking shoes also grew 3.6% to $51.6 million, while sales of its Sanuk shoes and sandals declined 4.4% to $30.9 million.
Deckers Outdoor Corp (NASDAQ:DECK)’s gross margin improved, rising year-on-year from 46.0% to 46.8%, but operating inefficiencies caused by higher SG&A expenses cause operating margin to drop from 4.8% to 1.0%. That decline is alarming, since constantly rising costs of sheepskin and leather are the top threats to the company’s profitability.
From this chart, we can see that Deckers Outdoor Corp (NASDAQ:DECK) has a major problem with its cyclical growth pattern – it appears that fourth quarter (holiday) sales growth, while decent, is topping out around the $600 million mark, while margins are declining and expenses are steadily rising. On top of all of that, Deckers still anticipates a full-year loss of $1.10 per share.
Despite Crocs and Deckers’ best attempts to diversify their product lines away from their core products, I still believe that their perception as “fad footwear” stocks is worrisome, since it has forced them to spend more heavily to remain relevant and ingrained in the public eye.
Therefore, I believe that investors should bet on another footwear stock that has been making a comeback recently – Skechers USA Inc(NYSE:SKX), which peaked at around $45 back in 2010, has risen 40% over the past six months on improving sales and a return to profitability.
Skechers USA Inc(NYSE:SKX) was once also regarded as a fad stock, due to its focus on shape-up toning shoes, which were in extremely high demand until 2010. When demand plunged in 2011, Skechers posted a 20% decline in annual sales to clear out its excess inventory of shape-up toning shoes at steep discounts, which also caused an annual loss of $0.60. To make matters worse, Skechers was sued by federal and state governments for deceptive advertising that claimed that shape-toning shoes could help wearers improve their muscle tone and lose weight.
As a result, Skechers now plays it safe with a diverse product mix of standard lifestyle and athletic footwear for men, women and children, with the majority of its sales coming from the United States.
During its first quarter, Skechers earned $0.08 per share, a complete surprise to analysts who had expected the company to post a quarterly loss of $0.13 per share. This was also a massive improvement from the loss of $1.18 it reported in the prior year quarter. Revenue also soared 39% to $395.6 million, fueled by strong sales of athletic shoes, such as its GoRun and GoTrain product lines.
Skechers also expects a fiscal 2013 profit of $1.03 per share, a 442% increase from 2012. Revenue is expected to rise 17% to $1.82 billion. On top of all this, Skechers’ SG&A expenses have been steadily declining, while Deckers and Crocs have been spending more heavily to remain relevant.
It’s easy to see why Skechers is a better growth investment at current levels than both Crocs and Deckers. While Crocs and Deckers are still mainly relying on core products for their survival, Skechers has already learned the lesson that fads should never replace a balanced portfolio of products.
Therefore, I believe that Skechers’ survival teaches investors a simple lesson about fad stocks as well as their own portfolios – to never put all your eggs in one basket.
The article Two Fad Footwear Stocks to Avoid and One to Buy originally appeared on Fool.com and is written by Leo Sun.
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