SWKS, SKX, CRTO: Which one is really the best bu

Which of these companies is the best buy right now? A simple minded investor might look at the P/Es of the companies and say that SWKS is the best because it has the lowest P/E.


        Price	TTM Adj EPS	P/E
SWKS	$97.71	$4.36	        22.4
SKX	$99.29	$3.21	        30.9
CRTO	$45.25	$1.13		40.0

P/E looks at a snapshot in time and says nothing about how fast the companies are growing. We know that faster growing companies should command a higher multiple on earnings. Thus, we have started using PEG or Saul’s version of the PEG which looks at the TTM Adj EPS over the prior year’s TTM Adj EPS. We have been calling this 1YRPEG. Here are the numbers:


        P/E	Growth		1YRPEG
SWKS	22.4	 76.5%		0.29
SKX	30.9	105.8%		0.29
CRTO	40.0	262.0%		0.15

I think this where many of the people who have been adopting the 1YRPEG will stop on their analysis of the numbers. They would stop there and conclude that CRTO is clearly the best buy because its valuation considering its growth rate is the best of the three. This logic makes sense so CRTO is the best, right? Not so fast. There are two things missing that we haven’t yet considered. The first one can be analyzed from just the historical numbers so let’s start there.

Yes, we care about valuation (P/E), and, yes, we care about the growth rate, but that doesn’t tell us the full story. I think we should also care about the rate of change in the EPS growth. What’s that? Well, it’s basically the acceleration or deceleration of the growth rate in earnings. Let’s stick with these three companies and look at the numbers. Then I’ll explain why we should care about the change in growth of adj EPS over time.

Full Yr Growth Rate


Period		SWKS	SKX	CRTO
3/14		22.9%	300.0%	N/A
6/14		31.4%	268.4%	N/A
9/14		46.6%	192.0%	695%
12/14		64.4%	151.9%	316%
3/15		76.5%	105.8%	262%
6/15		74.3%	 65.7%	159%

Interesting, huh? You can see that SKX and CRTO are rapidly decelerating in their adj EPS earnings growth while SWKS was accelerating and may now stabilize. Note: that the 6/15 growth rates are predictions. For SWKS, I took the midpoint of company guidance (which they will likely beat). For SKX, I took company guidance (which they will likely beat), For CRTO, I estimated €0.25 in adj EPS which I tried to estimate based on company adjusted EBITDA guidance. Saul has mentioned a few times that he likes accelerating adj EPS growth but I don’t think he explicitly explained why this is an important consideration. I think that an easy way to think about it is that an accelerating EPS growth rate will help keep PEG low as the stock price rises with increasing earnings whereas a decelerating EPS growth rate will drive the PEG up as the stock price rises in response to increasing earnings. Put simply, an accelerating growth in EPS will allow for more upside in the stock price without letting the PEG get too high. To illustrate this further, let’s look at the change in PEG of each company. We will compare the PEGs today and then project what the PEGs will be after next quarter’s earnings reports assuming that the predictions are met.


1YRPEG	SWKS		SKX		CRTO
3/15	0.29		0.29		0.15
6/15	0.27		0.43		0.22

This really illustrates how important the acceleration of EPS growth is to the future. After only one quarter, we have CRTO worsening from 0.15 to 0.22, and SWKS improving slightly. SKX declines by a significant amount. While CRTO will still have a better PEG than the others, it won’t be better than SWKS in the 9/15 quarter if the acceleration trends for the companies hold. SKX has been rapidly decelerating in its EPS growth rate and unless we see reacceleration, we will begin to see either a) a limit to the stock price appreciation, or b) a higher valuation than we might feel comfortable with. So this acceleration/deceleration in adj EPS is that first thing that we were missing in our analysis.

The second thing missing has nothing directly to do with historical numbers although we can use historical numbers as a partial gauge to extrapolate into the future. The second missing thing is to try to predict what the future will hold. This is done by weighing the various information that we can gather. There will be a wide range of possible analyses and every person will form their own opinion. It’s basically about coming up with an estimate of what EPS might be in the future. To complete this exercise, I will offer my opinion of the future for the 3 companies.

SWKS
*Great PEG
*Accelerating EPS growth
*Increasing margins
*Gaining market share
*Very strong competitive advantage
*Very rapidly growing target markets
*Multiyear visibility into future business
***Assessment: high probability of sustained high EPS growth

SKX
*Great PEG
*Decelerating EPS growth
*In the middle of international expansion (`2 more years to get to 50% of sales)
*Temporary problems limited recent growth (port shutdown, currency, distribution center inefficiencies)
*Increasing pricing without slowing growth (shows strong brand)
***Assessment: EPS growth will likely continue to decelerate but deceleration may slow; probably at least 2 more years of good growth

CRTO
*Great PEG
*Rapidly decelerating EPS growth
*Increasing customers
*Increasing revenue per customer
*Spending more in 2015 (EPS lower as result)
*Business requires low CapEx
*Technology can change quickly (watch for customer acquisition growth decline and spend per customer decline to predict decay to competition…so far so good)
***Assessment: PEG is low due to very high 1 year EPS growth rate so too much deceleration in the EPS growth rate makes this company susceptible to being less of a great bargain.

Based on the above, I think that all three of these companies are outstanding bargains at current prices. The future is uncertain, but, if I had to rank them, I would rank SWKS the best choice, CRTO second, and SKX third. This is a very different assessment that I would have come up with by just looking at the 1YRPEG.

Chris

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Chris,

Nice job…something to think about. Curious to see others’ opinions. Many thanks.

Andy

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NICE! Using first and second derivatives…

And my wife tells me that “all that math” doesn’t have value.

-Frick

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I would rank SWKS the best choice, CRTO second, and SKX third.

One thing I’d definitely add about CRTO is that they seem to be building a nice moat: the more internal data they gather from various companies, the better their algorithms are going to be, and the better service they can provide. It’d be very hard for someone else to just walk in and somehow gather all that data from those companies – it’s private, sensitive stuff – so that’s definitely a moat in the making IMHO. The more CRTO can grow, gather data, improve their algorithms and therefore the effectiveness of their service, the more clients they’re likely to win, and that translates into even more data that can be used to improve their algorithms in a virtuous cycle.

Neil
Long CRTO, SWKS, SKX

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NICE! Using first and second derivatives…

And my wife tells me that “all that math” doesn’t have value.

Exactly right. When I was explaining this to someone earlier today, I used the analogy of velocity (1st derivative) and acceleration (2nd derivative) in explaining it. I was never really good at calculus. Even though this uses the 1st and 2nd derivatives, no knowledge of calculus is needed to apply the method!

Chris

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One thing I’d definitely add about CRTO is that they seem to be building a nice moat: the more internal data they gather from various companies, the better their algorithms are going to be, and the better service they can provide. It’d be very hard for someone else to just walk in and somehow gather all that data from those companies – it’s private, sensitive stuff – so that’s definitely a moat in the making IMHO. The more CRTO can grow, gather data, improve their algorithms and therefore the effectiveness of their service, the more clients they’re likely to win, and that translates into even more data that can be used to improve their algorithms in a virtuous cycle.

Neil,

It may work out the way that you say.

But I’d like to make a counter argument.

The SWKS business is built on a lot of knowhow that is impossible to replicate in a short time period and without billions of dollars of investment including the licensing of lots of IP. Its customers are working on multiyear projects with SWKS and will be very difficult to grab away. Also, a new competitor will have years of heavy loses until then get enough scale to be profitable.

The SKX business is build on a brand of growing strength and tens of millions of dollars of investment in distribution. A decline in its business is possible but not as likely.

CRTO’s business is the most susceptible to be taken away. Technology moves very quickly, and a new approach may be developed by someone else. Losing a customer can be as fast as a phone call moving away the marketing budget from CRTO to another company.

I argue that SWKS is the safest franchise, SKX is the second safest, and CRTO is the least safest.

Chris

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“I argue that SWKS is the safest franchise, SKX is the second safest, and CRTO is the least safest.”

Completely agree!

Those circumstances you are referring are the variables that the maths and computer programs don’t tell in stock analysis.

Maria

Chris, what a wonderful evaluation, and a great way of thinking about it. I had come to the same conclusions, probably for the same reasons, but without spelling it out to myself so elegantly. I added a lot to my already large SWKS position, I added less to my big, but a lot smaller CRTO position, and I didn’t add to my SKX position (which was my second largest and thus already quite oversized). I think SKX can grow a lot more (it’s only two or three percent the size of NIKE as I remember), but I figured I had enough.

Thanks

Saul

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Gaucho Chris posed the following questions to me:

I’ve been thinking about earnings growth acceleration more. I’ve seen you mention that you like when you see a company with growth acceleration. Here are some thoughts on that:

1) You mentioned in your reply to that post that you came to the same conclusions as I did. Was this intuitive for you or did you actually consciously factor EPS growth acceleration/deceleration into your assessment and subsequent decisions?

2) When you chart stocks on your graph paper (I haven’t been doing this), I think the EPS growth acceleration/deceleration will become visually apparent. I wonder if we can come up with a new metric that takes this into account the acceleration/deceleration. Perhaps we can take the take 4 quarters plus the projected next future quarter’s EPS growth rates and determine a fitted slope to come up with a single acceleration/deceleration value which could be used in our evaluation of the stock. I think this will be useful for predicting following::

a) How much fuel is left in this stock meaning how much room it has to run. It makes sense that if we buy a currently low 1YPEG stock, a decelerating EPS growth rate will more likely raise the 1YPEG in each subsequent future quarter. Whereas if we buy a currently low 1YPEG stock, an accelerating EPS growth rate will be able to maintain a low 1YPEG in future quarters even as its stock price rises. This will give the later stock a lot more room to run up. And I think this is exactly the reason why you recently added to SWKS and not to SKX.

b) To complete this thought exercise, can we come up with a single metric that will tell us (given a few future EPS predictions) how much upside a stock has in it? I think this would make our buying and deployment decisions more based on calculations than on your intuitive ability to see things that others don’t.

I responded: “You sent a bunch of great questions. I do factor in acceleration or deceleration of earnings. They show up nicely on my trailing earnings monthly graphs. I have a very nice visual of an ascending line. This is at about 45 degrees for BOFI, for instance, but with a slight increase in the slope to show that its earnings growth is accelerating. CRTO goes about straight up (coming off a small base), but because of the law of large numbers it’s starting to slightly flatten from perhaps an 80 degree ascension to a 70 degree one, and I can see that it will reduce its rate of growth, but because it is so high, it can reduce quite a lot and still be growing pretty fast for a good long time so that doesn’t worry me for now. PSIX and POL decelerated this quarter, and their outlook was for more of the same. Their 1YPEG’s are still under 1.00 though because 1YPEG’s look back four quarters, but looking ahead I can see that the 1YPEG’s will be rising in future quarters as the trailing growth rate reduces….I think this is the kind of way of looking about it that you were asking me about.

I’m not sure we can come up with a single calculation that will give you all the information that went into your thinking about SWKS, for instance. For me it was the CEO explaining how they are included in the planning way in advance, and how they are an integral part of a complicated system, and my concluding that no one is going to replace them because they find a new supplier a dollar cheaper. They simply can’t! They are in all the platforms forever. And their margins are rising to prove it. And the CEO said that they are in every manufacturer, and almost every platform of every manufacturer. Holy Mackerel ! And they are at a PE of 22 with a rate of growth of trailing earnings of 77% ??? The market is blinded by them being up over 100% in the past year, but if analysts would stop price anchoring and look at them as they are, right now, they’d see them as wildly undervalued. (Gee! I might convince myself to buy some more!) It’s hard to imagine a single metric that would give one that much confidence. It’s largely subjective, I think.”

Please feel free to join in the discussion!

Saul

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I argue that SWKS is the safest franchise, SKX is the second safest,
and CRTO is the least safest.

At today’s prices, you may very well be right. All three of these have done really well since ~mid 2014 (when the longest of these, CRTO, landed on my radar and I bought in at $30.50 – a nice 50% gain for me on that one).

In terms of diversification (across industry segments, risk factors, domestic/international, market cap, etc.)… well, I’m just going to point out that all three of these have good things going for them and you could do worse in spreading out some diversification across your holdings. Why not build positions on all 3 based on your own level of risk tolerance and timeframe?

/me is long on all 3, as it turns out…

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In terms of diversification (across industry segments, risk factors, domestic/international, market cap, etc.)… well, I’m just going to point out that all three of these have good things going for them and you could do worse in spreading out some diversification across your holdings. Why not build positions on all 3 based on your own level of risk tolerance and timeframe?

Holy Grail,

Please see post #384 for my thoughts on diversification:

http://discussion.fool.com/thanks-for-posting-saul-based-on-your…

My current position sizes on SWKS, SKX and CRTO are as follows:

*SKX: 14.8% with average cost basis of $57.80

*SWKS: 13.1% with average cost basis of $76.71 (but I’ve realized significant gains with decreasing my overall position size this year as I was trading options so my cost basis would be much lower if I hadn’t taken any gains)

*CRTO: 8.4% with average cost basis of $45.40 (recent addition and I went in big from the start which I normally don’t do)

In addition, I have Jan17 calls on SWKS ($90 and $95 strike) and SKX ($65 and $90 strike). I have 3x as many calls on SWKS as SKX so my exposure to SWKS up side is a bit higher than it is for SKX.

In addition, I have short put positions on all three stocks.

Overall, I have 36.3% of my portfolio in these 3 stocks not considering the options positions. Yes, I realize that this is very aggressive so I am watching these companies very closely. I listen to all the conference calls, I model the business results as well as the business metrics, and I follow every bit of news that will give me clues to changes of my future assessment of these companies include my assessment of their earnings growth and ability to compete in their markets.

Chris

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