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.
*Accelerating EPS growth
*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
*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
*Rapidly decelerating EPS growth
*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.