Why You Should Buy Deckers For The Long Term

Jul.27.12 | About: Deckers Outdoor (DECK)

Deckers Outdoor Corp. (NYSE:DECK) just reported a smaller-than-expected second-quarter loss, which sent its shares soaring in the after-hour market. You may be reading this article because you are a trader but I believe that the shares of Deckers, at their current price, represent a long term investment opportunity.

One of Peter Lynch's favorite ways of finding a good stock to invest was to take his family shopping at a large shopping center and see how each store there was doing. It was no wonder that he picked up Gap Inc. (NYSE:GPS) during its early stage of the franchise's nationwide expansion and captured the huge run-up of its stock price for the investors of his fund.

Of course, for you to invest in the shares of a company, it is not enough that you like its products or see a huge crowd in its store. Its stock might have been overvalued by then. The company might have reached its full growth potential already, like today's Gap Inc. Or worst yet, the company might have gone ahead of itself in its aggressive expansion and before you know it, it is crushed by the heavy debts it has borrowed to finance such expansion.

So to find a product that you like is only the first step. You need to do your homework before you use your hard-earned cash to buy a fraction of the future earning of a company that produces or sells that product.

I have to confess that in the case of Deckers, I did not do what I am preaching to you. I fell in love with the UGG boots in December 2006, but did not do my homework on Deckers until very recently. However, I think the recent decline of its stock price actually has provided a good entry point for individual investors. Below are the reasons:

First, Deckers has zero long term debt. Substantial amount of long term debt could bring down a retailer company. Retailers that sell consumer discretionary items tend to fall prey to the ups and down of economic cycles. Without substantial long term debt, a retail company is in a better position than its competitors with a lot of debt to survive a recession, and also survive the mistakes it might make during its own expansion.

Deckers debt/equity ratio is lower than a lot of its competitors. For example, Nike (NYSE:NKE) has a total debt/shareholder equity ratio of 3.5. Better yet, Deckers do not have a lot of its own stores and the CEO has indicated that it does not plan to have more than 50 of its own stores. It also represents an advantage in terms of financial flexibility. A lot of retailers have significant amount of long term lease payment obligations for their huge number of stores, which put a huge recurring financial burdens on their business. Circuit City was forced into bankruptcy primarily due to its store lease obligations.

Second, measured by price/sales ratio, price/EBITDA, P/E ratios, the common shares of Deckers are reasonably priced. For the full year 2012, it is expected to have net income of about $4.56 to $4.61 per share, which translates into a P/E ratio of roughly 11 even if the price reaches $50 per share. For a company that still grows its revenue at double digit percentages each year, that is an attractive valuation.

Third, as measured by return on equity, return on assets and net margin, the company is relatively well managed.

Fourth, the interests of the management team of Deckers are aligned with those of the public shareholders, as the insiders own about 6% of the common shares. The recent purchases by a few insiders also show that the insiders are confident about the direction and the future of the company.

However, a note of caution is due here. The price of a consumer discretionary stock tends to be very volatile. I would not be surprised if the share price of Deckers goes through huge ups and downs in the future. If the share price declines, you need to have the stomach to stick to the investment decision you make, and to do that, you need to have done your homework and have conviction in your own initial investment decision.

Disclosure: I am long DECK. I have no positions in Gap Inc or Nike, and do not plan to initiate a position within the next 72 hours.