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After looking at different industries and comparing average return on equity to average price-to-book multiples, footwear and apparel accessories stocks appear overvalued in aggregate. Using this top-down approach to choose industries for a net-short position, attractively-priced stocks and overpriced stocks were identified among footwear and apparel accessories purely on the basis of valuation and growth prospects.

Why create a fully or partially hedged position?

Alpha hunters might consider net short positions in industries trading at indefensible multiples, market neutral positions for fairly valued industries, and net long positions in industries with attractive valuations. If they are willing to hedge their positions, they can find more investment opportunities than they would by just hoping to find the best industries or stocks to buy today. Instead, they can use fully or partially hedged positions to bet on the mean reversion of different stocks in an industry while minimizing or reducing exposure to industry and market volatility.

Valuation Matters

This analysis is based purely on growth predictors and past valuations. It is not based on which fashions are in or on personal hunches about where a stock is going. I would rather provide valuation-based recommendations which are validated by the persistence of the value effect than inklings which have not been tested as being predictive. Media attention to firm specific details is contrary to investment based on financial metrics. Though the value effect has been empirically demonstrated many times over, financial news often showcases other factors which are not proven to be predictive of future returns and are in my view distractors from what is important. They are left out on purpose to focus on value and growth.

Footwear and Apparel Accessories Stocks

Growth and value were reconciled in this industry by plotting a measure of growth on the y-axis as a function of a measure of cheapness on the x-axis. Historical price-to-earnings multiples, price-to-book multiples, and price-to-sales multiples were used as measures of cheapness. Analyst estimates for earnings growth, historical return on equity, and historical sales growth were plotted as measures of growth.

Plots of these companies reveal how some stocks are much more attractively priced than others:

(click to enlarge)Earnings Growth vs. PE

(click to enlarge)ROE vs. PB

(click to enlarge)Sales Growth vs. PS

Ticker

Company

P/E

P/S

P/B

Growth Est

Sales Growth

ROE

COH

Coach

17.7

3.8

9.0

14.5%

12.8%

57.6%

CROX

Crocs

13.2

1.5

2.8

17.5%

23.1%

23.7%

DECK

Deckers Outdoor

10.4

1.2

2.4

16.6%

35.2%

25.6%

ICON

Iconix Brand Group

13.1

3.5

1.1

9.3%

35.6%

9.5%

NKE

Nike

21.2

1.9

4.4

10.3%

8.1%

22.0%

SHOO

Steven Madden

18.7

1.8

3.7

13.2%

15.3%

21.9%

SKX

Skechers USA

0.0

0.7

1.2

15.0%

5.9%

-6.2%

VRA

Vera Bradley

15.3

1.8

6.0

19.5%

19.5%

49.0%

WWW

Wolverine World Wide

19.0

1.5

3.5

11.3%

4.3%

18.4%

Data from finviz.com

Crocs and Deckers were found to lie among stocks in the upper left of these plots (higher growth, undervalued stocks) while Wolverine World Wide and Coach were found to lie at the lower right of these plots (lower growth, overvalued stocks). Based on this work, a net short position for footwear and apparel accessories stocks can be constructed by buying CROX and DECK shares while hedging with a larger total short position in WWW and COH shares.

A long/short position using different stocks is not a perfect hedge, so care must be taken to monitor shorts so that they do not grow out of hand. Alternatively, the short positions can be created by buying put options.

Please read the article disclaimer.

Source: Footwear And Apparel Accessories: 2 Longs And 2 Shorts