Don’t always buy low, sometimes even beaten up stocks deserve to go lower.
As investors, we are always searching for undervalued stocks beaten up unfairly by the Street. However, the old adage of buy low, sell high, may get investors into trouble when multiple contraction starts to set in. Earlier this month, I stumbled upon a couple, once hyped, tech stocks whom as of late have seen weakness. Let’s take a second and review another old investing adage, the value trap.
The basic definition of a value trap is any stock which appears to be trading at undervalued levels but unfortunately never improves due to slowing growth. I would like to highlight Skullcandy Inc (NASDAQ:SKUL) and Zagg Inc (NASDAQ:ZAGG) as two potential value traps investors should consider carefully before entering a long position.
Broken buds
Let’s first take a look at Skullcandy Inc (NASDAQ:SKUL), an audio technology company which hit the market just a couple years ago. This highly anticipated IPO was welcomed to the market with open arms, priced at $20 per share, above the expected range of $17-$19 per share. Well, if you bought the IPO, you’re hurting pretty bad, shares have moved lower by roughly 70%.
Trading at 8 times earnings, you may be inclined to pick up some shares at historically low valuations, right? Hold on, last month, the company reported a dismal quarter where it announced declining revenue, margins, and earnings. Skullcandy Inc (NASDAQ:SKUL) lost $9.8 million as revenue declined 30% and margins declined 3.6%. Management remained positive amid these struggles, the company is looking to change its reputation by upping its price point.
Currently, the company is known for a selling primarily inexpensive earbuds which are very similar to the technology available on eBay Inc (NASDAQ:EBAY) for only $0.99. Going forward, the company is looking to focus on higher priced products to stop the growth slowdown. Unfortunately, management doesn’t realize Skullcandy isn’t Bose, without a reputation for high quality merchandise, and I fully expect these products will see little success. Analysts are expecting the company to see earnings decline by 85% over the next year. I hate to see companies look to solve their problems by changing business models, it usually aggravates the problem.
Damaged goods
Next up, Zagg Inc (NASDAQ:ZAGG), a company which designs an array of consumer electronic accessories with a focus on mobile. ZAGG shareholders have had a tough couple of years, shares are down 27% this year alone. Trading at 6 times earnings, you may be inclined to pick up some shares at historically low valuations over here as well.
The company reported an awful quarter last month where it announced declining revenue, margins, and earnings. I’m not trying to be repetitive, but there are many similarities. Earnings declined 80% as a result of global weakness combined with slipping margins.
Zagg Inc (NASDAQ:ZAGG), like Skullcandy Inc (NASDAQ:SKUL), operates in a very competitive market. The company competes with many competitors including Lifeproof, Otterbox, and an assortment of Chinese manufactures. I’m not sure Zagg Inc (NASDAQ:ZAGG) can ever maintain strong growth again. The thesis behind ZAGG is cemented in mobile technology growth. As we see this growth, new competitors will continue to enter the market, driving out economic gains over the long run. Additionally, new competitors like Lifeproof have simplified the protection process. Why buy a Zagg Inc (NASDAQ:ZAGG) case and screen protector when you can get the full package from Otterbox or Lifeproof?
Throughout the company’s history, sales have been tied directly with the launch of additional Apple Inc. (NASDAQ:AAPL) products. ZAGG derives the majority of its revenue from the Apple customer which bodes well when Apple is innovating. As of late, however, Apple Inc. (NASDAQ:AAPL)’s products aren’t seeing the same growth as before, in turn slowing ZAGG’s sales.
