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On September 19th I published an article on Skullcandy (NASDAQ: SKUL) that discussed the stock's huge dive in reaction to a big downgrade by Morgan Stanley analyst Jay Sole, which lowered the stock from a price target of $21/share to $15/share and stamped an ugly "equal weight" on the struggling ticker.

Defending the stock, I cited the company's "Apple-beating" 38% year-over-year revenue growth, the company's terrific profit margins of 49%, the company's lack of debt, and (perhaps most importantly) the HUGE short 11.25 million shares worth of short interest (about 78% of floated shares.) Based on this information, I called for a huge short squeeze and a big short-term recovery in SKUL on the heels of that move. I was right about the short squeeze and the short-term price action, but the extreme downward pressure in SKUL that was introduced in October and November was very surprising.

Between September 28th and November 15th, SKUL short interest (shares short) dropped from 10.37 million to 6.87 million. One would think that the buying of 5 million shares of SKUL (over a third of the total number of floated shares) would cause positive movement in the stock's price, but this wasn't the case. SKUL actually moved about 30% lower, and now sits at $8.62/share.

The company's Q3 2012 results from November 1st, which can be seen here, weren't bad either. Sales increased 17.1% relative to Q3 2011, income jumped 29.1%, and the company's expenses increased at slower rates. One of the highlights of the company's earnings release was the 2012 full-year net sales revenue estimate, which was changed from $280-300 million to $290-300 million.

The real reason that Skullcandy dropped in November was because of the company's revised earnings outlook. The company replaced their previous 2012 full-year EPA projection of $1.10-1.20 with a more cautious estimate of $1.00-1.04.

Although I do acknowledge that SKUL should trade in reaction to its earnings, a little perspective is also important. SKUL lost about 30% of its market capitalization (well over $100 million) based on a slightly more conservative EPS estimate made ahead of the holiday season. Talk about an overreaction.

I think SKUL is an attractive buy ahead of the holiday season, although there should be some concern about the trajectory of the broader market too. The stock should not have too much trouble returning to the $12-16/share range it enjoyed earlier this year assuming that it continues its impressive rate of growth.

Source: Revisiting Skullcandy's Massive Short Squeeze