Investment Lessons Learned from Crocs

Believe it or not, when it comes to investing, I’m not a big reader of news and opinion pieces–I prefer to listen to the market itself. I usually check the headlines but that’s about it. (Company-specific news is different; I do check the news on all my stocks each day, just to know what’s going on.)

But I couldn’t help noticing when, on a major news website the other day, I saw the headline, “Once-trendy crocs could be on last legs,” with a subtitle that read “100 million foam clogs were sold in 7 years, but the firm is now in trouble.” It made me a little sad … but also reminded me of a couple of the most important lessons for investors.

Crocs (CROX), the company, always seemed to be the butt of many jokes. After all, the company simply made “plastic shoes,” and their traditional clogs were generally very ugly–bright yellow, pink or orange, among other colors. By 2006, knockoff shoes were already hitting the market. I honestly don’t know anyone that really loved Crocs; at best, most people thought they were cute for little kids.

Amid this sentiment, we recommended the stock in October 2006 at a price of 16.

Why? Well, here’s where the first lesson comes in: Know what characteristics really count when picking a stock, and which ones don’t. In terms of what counts, you have sales and earnings growth (both were growing at triple digit rates for CROX), institutional sponsorship (Fidelity had recently bought a chunk and the stock had built a great launching pad), big margins (18.3% in the second quarter of 2006), a high return on equity (57% in 2007) and a huge mass market–there were potentially tens of millions of customers around the world.

Criteria that DON’T matter include what everyone thinks of the company. In fact, there’s usually an inverse correlation with young growth stocks’ performance, and common perception among investors–the more it’s hated, the better the chance it has to become a big winner as those early doubters eventually change their minds.

And many did just that, as CROX soared from 16 to as high as 75 within the next year. It was a good bull market, but this one was one of the best glamor stocks out there, rewarding early investors in a big way. We sold a third of our shares that June around 45, but held the rest until we saw clear signs of a top. That sign came on November 1, right after the company reported earnings.

On its earnings news–which, by the way, was terrific, with sales and earnings up 130% and 144%, respectively, well ahead of estimates–the stock plummeted, falling 36%. In one day! After a heady advance, that was a clear signal the run was over. We sold all our shares the next day.

Of course, with CROX down that much in such a short period of time, and on “good” news, most investors had trouble selling their shares. And that brings up another lesson–every stock, no matter how good the story, is going to top out. Every single one! When these leaders top out, on average, they fall 70% from their peak before bottoming. That is a historical fact. As it turns out, CROX went straight down after gapping lower, eventually falling to 80 cents a share!

All of this leads to last week’s article, which stated that Crocs lost a whopping $185 million last year (I think that included some charges), laid off 2,000 workers and had to scramble to find ways to pay off its debt. Even now, Crocs’ future is in doubt; sales were down 32% last quarter, earnings were a negative 27 cents a share, and the stock, now just above 3, is still down 95% from its all-time high.

Now, I’d be lying if I told you I predicted CROX would fall so far, so fast. What happened to the company, however, wasn’t unforeseen–many times consumer product companies that experience explosive growth end up expanding way too fast. And when things hit the fan, it turns out the company has too much inventory, too many employees and too much cost everywhere.

However, the trick is not to jump the gun. In the case of Crocs, many of the early bears of the stock were eventually proved right … but in reality, where did that get them? The stock quintupled during its bull run before it collapsed. And that leads to the most important lesson of all–have a sound system of rules and tools to guide you in the marketplace. Without them, not only might you miss an opportunity to own a stock like Crocs on the way up, you might get in way too late and hold it on the way down.

As for CROX today … forget about it. The stock might rally if the market does, but its glory days are long gone.

Comments

[notsosmart:]

also switched to china & made an inferior product compared to the original made in canada & here.we could tell the difference right away & called them.they could not care less.

Jul 27 10:42 AM

[oilsands:]

The other day a friend mentioned CROX and said that their main problem was that the materials of the original were too good; they didn't wear out. Built in obsolescence, so much a part of American incdustry, might have helped them. Maybe it's not too late for that approach. Crox still has a solid customer base, the company just needs to be better at assessing its realities and adjusting to them.
Taking a profit before the institutional investors do is the key to this story.

Jul 28 10:26 AM

[Nyetnichevo:]

This is such a facile analysis based exclusively on hindsight; if the author never met anyone who liked Crocs, why was he buying the stock? Crocs are loved by millions of people and the styles have evolved past the hideous appearing sandals that so many loathe about the brand. But try some of the other sandals or the Santa Cruz loafers, etc., they are fabulously comfortable and stylish too. Nurses love Crox, the beach crowd wears them, and they are sold in dozens of countries as well. This is a sleeper stock to accumulate now. They are not going away either, the company has a large cash position and relatively manageable debt. Also, they have new management and are restructuring to scale inventory and bring the company back to solid growth and profitability. It could also be a valuable takeover target as other purveyors do not underestimate the power of the Crocs brand. Now that weak hands have been frightened out of the stock by writers such as the author above, it's a classic case of buying a great company with solid products at a fantastic discount that is out of favor and hated by the investment community. I am long 1250 shares for full disclosure and own 4 pairs and countless shirts which are great apparell as well and will just wait patiently for the turnaround....be it a year or 5 it hardly matters. The author also fails to mention what could happen if Crocs becomes very successful in China, India, Russia, and Brazil. People everywhere want "happy feet" and there is no more comfortable shoe than Crocs because I have tried them all.

Jul 28 11:30 AM

[oilsands:]

Nyetnichevo's comment are correct. The possibility of them gaining traction abroad are quite real. Foriegn sales are growing.
Doctors are now recommending them for patients with a need to protect their feet. My daughter used them to finish a 60 mile hike (over a weekend) for an MS fund raising event. She developed blisters while using supposedly superior cross trainers, then switched to CROX and walked the next 33 miles with no problem.
Many, many companies have problems with rapid growth and expansion. This one will turn around.

Jul 28 12:26 PM

[crocsdealer:]

I am a long time crocs retailer and I can tell you that the new product lines from crocs still sell very well in my store. We sold EVERY pair of the Cove model within 2 weeks of getting them this past spring.
I met with the crocs rep last week and checked out the spring 10 line up. It is awesome! We order $ 25,000.00 in product for next spring and we are only a mom and pop outfit.
We are small retailers telling you that most of the critics do NOT understand the hard core product fan base of Crocs.

Aug 01 11:05 AM

[kevinmarmon:]

I read on another blog that CROX was being accumulated by Roy Sebag of Essentia Equity and thats why its running up. The rest of the shares are apparently held by the likes of Bill Gates through his investment vehicle Cascade in addition to Barclays and Mazama Capital.

Aug 06 11:41 AM

[Hu Tin:]

Well, the stock did a huge rally today after hours. The price is above $5 now. And I am wonder if this is an overbought or there is still more to run. My twitter: twitter.com/quanghoc

Aug 06 11:52 PM