I want to stress on this first, so you can understand more about my investment philosophy: I am a value investor. I am not a value pretender. Value pretenders focus on Wall Street ratios that business people could care less about. Do you think the management at Deckers is worried about its PE ratio or PB ratio? Do you think management is concerned about its stock's beta? Trust me. It is not. Management cares about one thing, cold hard cash needed to keep the doors open. And as a true value investor, I am mostly concerned with cash too.
It is important for you to understand the type of investor you are. My articles are geared only toward real value investors who understand that the price of the stock has nothing to do with the value of the company. Ben Graham gave us three great contributions: (1) Price is what you pay and value is what you get, (2) Mr. Market is moody, bi-polar and irrational, and (3) The investor is his own worst enemy. I want you to think about these three points as you read through this article.
Now, when evaluating Deckers as with any other company, I need to figure out what the company is worth today. To do this, I need to estimate how much cash the company will generate for its remaining life and then discount the value of that cash back to today. To figure out how much cash the company will generate, I first have to figure out what the owner earnings have been for the last ten years.
But first what are owner earnings and why are we not concerned with reported earnings? The best example I have heard to describe the difference is this: Reported earnings can be compared to what you report to the IRS on your tax return every year. Owner Earnings are the physical cash you have at the end of that same year.
On your tax return, you get to deduct your home mortgage, but you can't deduct all the food you bought. You can deduct dependents, but you cannot deduct the cost of gas to put in your car or the new TV on your wall. When you think about your own net worth at the end of the year, do you base it on what you reported on your tax return or by how much cash you have after everything is said and done?
Shouldn't we think about companies in the same way? Do we care that a company is able to depreciate an asset for so many years? No! We care about how much they have to continue to grow the business.
According to Warren Buffett, owner earnings are "reported earnings + depreciation, amortization, other non-cash items - average annual amount of capitalized spending on plant, machinery, equipment" (and presumably research and development). It is a simple formula with no Greek letters.
I saved you the time to calculate owners' earnings for Deckers for the last ten years.
Here is the last ten years (in $Mil):
Looking at these numbers on a graph:
From this, I can comfortably say that management is bringing in more cash every year then it sends out. I can also comfortably estimate that the business is growing in a predictable pattern. Not many companies look this way on a graph, so be happy that I did all the digging for you.
Next, you have to project the next 20 years of owners' earnings, I use CROIC. (If you don't know what CROIC is, you should buy the book, F Wall Street by Joe Ponzio.) Forecasting is an art and not a science. Everyone will come up with different forecasts. So I don't want to present my forecasts on here. I'll simple reiterate what we learned, Deckers is generating cash and using that cash to grow.
Let's end with a quote by Warren Buffett, as I think this applies more than ever:
"Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market."
And one quote by Ben Graham:
"The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator's primary interest lies in anticipating and profiting from market fluctuations. The investor's primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell."
Finally, I want summarize what really happened to Deckers Friday: Deckers got beaten down by 25% because it had a bad quarter in Wall Street's eyes based on its reported earnings (think tax return).
Additional disclosure: I am not long DECK, but will be buying shares in the coming weeks.