Economic Recovery? Yes, Part II!
Crocs (CROX) and Lessons Learned
Potential Earnings Winners Later this Week
I want to lead off my Cabot Wealth Advisory today with a quick follow-up from my last one: http://www.cabot.net/Issues/CWA/Archives/2009/07/Off-the-Bottom-Tricky-Game.aspx, where I wrote about the Economic Cycle Research Institute’s Weekly Leading Index. A couple of weeks ago, the growth rate for the leading index was at plus 4%, the first positive reading in two years and a definitive sign that the economic recovery was on track.
Most people didn’t believe that, considering the awful June employment report and news of continued layoffs. But employment has always been and will always be a lagging indicator–while it’s probably the most important measure of how people feel and of their personal financial situations, it’s useless as a leading economic indicator.
Since my write-up, a couple of additional data points have been released, and the Weekly Leading Index is growing even more positive–its growth rate has leaped from plus 4% to 6.2% to 7%! And if the recent surge in the stock market (which itself is a leading economic indicator) means anything, there’s no reason that the growth rate can’t get into the double digits, signifying a powerful recovery.
Again, the economy and the stock market are two different animals, so I wouldn’t use this data as an excuse to buy stocks. But I have found it personally useful, allowing me to shrug off the seemingly endless barrage of bad economic news and opinions out there, especially among my friends.
So next time people are dragging you down with worried outlooks on the economy, tell them to drop the pessimistic attitude and listen to the facts at hand. Things are getting better!
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 Web site 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 glamour 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.
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Instead, you should focus on the leaders–the stocks that held up well during the market’s five-week correction and have just bolted to new peaks on big volume. But this is also earnings season, so even if you haven’t jumped on board some recent breakout stocks, there should be plenty of opportunity to get on board after some earnings gaps.
To review, powerful gaps higher (10%, 15% or more) right after earnings reports usually lead to higher prices. Most investors are afraid to buy a stock that’s just risen 20%, but if that gap comes after earnings, buying at that time is usually your best move.
Looking ahead, here are some stocks I’m watching:
Chipotle Mexican Grill (CMG) reports tomorrow night (July 22). A big gap above 93 (hopefully higher) would be highly bullish, especially as CMG has been building a nice-looking base since late April.
Amazon.com (AMZN) reports on Thursday (July 23). The stock has also been etching a launching pad for a couple of months, and I’d love to buy this stock on a solid 10% to 15% gap higher on earnings.
Netflix (NFLX) also reports on Thursday, though this one is a bit trickier. It has overhead resistance around 50, so it would have to clear that hurdle to get me really interested.
Baidu (BIDU) also reports on Thursday (busy day!). The stock just broke out of a nice five-week base on big volume, but it’s not overly extended. If you happen to get a big, liquid stock like this to gap up significantly, it would be a definitive sign of new leadership.
Of course, if these or other stocks gap down on their earnings, then all bets are off; I don’t advise placing big bets ahead of earnings because, frankly, it’s more like gambling than investing. Instead, just watch how these stocks perform the day after their earnings reports. If one of them has a monster gap up, I think you’ll be looking at a powerful leader of the bull move.
All the best,
Editor’s Note: Michael Cintolo will be watching the stocks above like a hawk this week and telling subscribers of Cabot Market Letter exactly what they should do when the earnings results come in. Mike secured his subscribers huge gains during the last six years, beating the market by a country mile. From the market’s bottom in March 2003 to the recent low in March 2009, the S&P 500 lost 18% and the Nasdaq lost 3.5, but Cabot Market Letter trumped them both, advancing a total of 94% during that time (nearly 12% per year)! Don’t miss out on Mike’s expert advice and the next mega gains Cabot Market Letter subscribers are sure to lock in during the new bull market!