Why Zumiez Should Survive the Downgrade

| About: Zumiez Inc. (ZUMZ)
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Zumiez Inc. (NASDAQ:<a href='https://seekingalpha.com/symbol/ZUMZ' title='Zumiez Inc.'>ZUMZ</a>)There’s nothing more frustrating than holding a winning position only to have a Wall Street analyst downgrade the stock and cut your profits. Subscribers to the ZachStocks Newsletter recently purchased Zumiez Inc. (ZUMZ) as it broke out to a new 52 week high, clearing a four week consolidation. The trade was profitable until Thursday when the stock gave up ground due to a downgrade from two second tier research outfits.

The downgrades came on the heels of March same-store-sales which were released by many key retailers after the close on Wednesday. The figures showed revenues for ZUMZ stores open over a year to be up 13.2% year-over-year. The numbers were ahead of the published expectations as analysts had been projecting growth of 11.8%. For the firm as a whole, sales were up 20% to 35.8 million – quite an impressive showing for a purely discretional apparel and sports equipment store.

I don’t necessarily disagree with the downgrades from a fundamental standpoint. ZUMZ is currently trading at nearly 40 times expected earnings for 2010 – a premium price even given the attractive growth rate of the stock. But despite the high multiple and the weakness of shares today, ZUMZ should quickly retake its bullish stance. The reason rests with the current market climate and the power of momentum and speculative buyers.

Today’s investor is primarily interested in high beta names which are most likely to achieve oversized growth. Individual investors whose accounts are still underwater from the peak value of two years ago, and mutual fund managers with a mandate to beat the S&P 500 are much less concerned with safety and anxious to capture as much exposure as possible.

This type of trading environment usually favors the high-growth speculative names. Since the retail and finance sectors have captured a good portion of the momentum trades, I expect these sectors to take a significant amount of bad news before they give up their relative strength. Many investors watching the strength in these areas have been waiting for pullbacks in order to deploy more capital. So with these buyers “waiting in the wings” the first pullback for strong retail and finance names will likely be bought.

Zumiez is likely to benefit from the phenomenon of Strategic Defaults. As homeowners give up the burden of paying mortgages on properties that are worth much less than the liabilities, money is freed from constrained budgets and more likely to be spent on discretionary items. So it would not surprise me to see Zumiez and other niche retailers post strong revenue trends in April and into the beginning of the year.

Only after the boost from strategic defaults has been fully accounted for will we start to see retail stock prices decline and in turn the fundamentals of the companies in question begin to wither. (remember, the stock price nearly always precedes the fundamental change.)

The ZachStocks Newlsetter has a stop of $19.80 for our long position in ZUMZ. If this level is hit, we will exit our position in the interest of risk control and save our capital for a better opportunity down the road. But for the time being, ZUMZ continues to look healthy and I expect a quick rebound in the shares as investors support the discretionary retail sector.

Zumiez Inc. (<a href='https://seekingalpha.com/symbol/ZUMZ' title='Zumiez Inc.'>ZUMZ</a>)

Full Disclosure: Author does not have a position in ZUMZ