The Value of P/E Ratios

 

The Value of P/E Ratios

What Happened to Liz Claiborne?

The Next Michael Kors (KORS)

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Today we start with a suggestion, which arrived in last week’s email.

“Greetings. I have a suggestion. It would be helpful if you could provide the current P/E for each stock in your Weekly Update. That would help me get a better feel for their present valuation and whether or not they have become overvalued in the marketplace since first recommended.”

Much thanks,

Edward S.
West Palm Beach, Florida

To clarify, Edward is referring to the weekly update I send out to readers of my Cabot Stock of the Month, which incidentally has done very well in recent months, taking profits of 107% in Stryker (SYK), 71% in Express Scripts (ESRX) and 80% in Yelp (YELP). The bull market, obviously, has helped. But we’re not done! Cabot Stock of the Month still holds eight stocks, with an average profit of 115%!

So how about Edward’s suggestion? On the surface, it seems reasonable. P/E (price/earnings ratio) is a popular measure of valuation, and having more data is generally regarded as a good thing.

But in fact, I am not going to follow Edward’s suggestion, and my reasons are these:

One, the fact that P/E is popular does not mean that it is always useful. As my mother liked to say, “Just because everyone else is doing it, doesn’t mean you need to.” In fact, in the investing world, when everyone knows something, that knowledge has no value! To be a successful investor, you’ve got to find knowledge that others don’t have.

Two, more data is not always better. In fact, one of the challenges in today’s “Big Data” world is freeing yourself from extraneous data. For the followers of Cabot Stock of the Month, this includes P/E ratios.

To be clear, P/E ratios do have some value for followers of Cabot Benjamin Graham Value Investor, which is the source of some of the recommendations in Cabot Stock of the Month. Value investing expert Roy Ward incorporates both a measure of current P/E vs. historical average P/E and a measure of earnings growth vs. P/E into his calculations—along with 44 other factors measuring value, quality, growth and technical strength—to come up with his Maximum Buy Prices and Minimum Sell Prices. Once you know those two all-important numbers, P/E ratios are superfluous.

And for the growth stocks I recommend in Cabot Stock of the Month, which are sourced from Cabot Market Letter, Cabot Top Ten Trader and Cabot China & Emerging Markets Report, P/E ratios are truly useless. In fact, we’ve found that the best growth stocks often have ridiculously high P/E ratios because the companies behind them are growing so fast and investors are looking so far ahead.

Tesla Motors (TSLA), for example, had a P/E ratio of about 200 at year-end, which is considered very high in most camps. Yet the stock is up 60% since then.

With growth stocks, the far more important numbers are the growth rates of revenues and earnings and the potential for the stock to become better known and better loved by investors (especially institutional investors) as time passes. That’s something that’s not easy to measure.

But it is possible to track charts on a daily basis, and from the charts, to infer whether a stock is still becoming better known and better loved—like Kate Spade (KATE) for example—or whether it’s past the point of peak perception, like General Motors (GM).

GM’s P/E ratio is currently 14, but I wouldn’t touch it with a 10-foot pole.

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KATE SPADE

Speaking of Kate Spade, I remember back in the 1990s when Kate Spade (the person) started as New York designer and retailer of handbags. Since then, the company has grown into a global retail powerhouse, with more than 80 shops in the U.S. and more than 100 shops internationally.

But what happened between that start and today is interesting.

In 2006, Liz Claiborne acquired Kate Spade for $124 million.

In 2007-2009, the Liz Claiborne business suffered horribly from a decision to make clothes for J.C. Penney (which caused its longtime partner Macy’s to slash orders). The Big Recession didn’t help, either.

From 2009 through 2011, parts of the beleaguered Liz Claiborne brand were gradually sold to J.C. Penney.

In 2012, what remained of Liz Claiborne Inc. was renamed Fifth & Pacific, focusing on three brands—Juicy Couture, Kate Spade and Lucky Brand Jeans.

In March 2013, Fifth & Pacific launched Kate Spade Saturday, a lower-priced “weekend” lineup targeted at younger women (who will eventually move up to the Kate Spade brand.)

In October 2013, Fifth & Pacific sold Juicy Couture to Authentic Brands Group for $195 million.

In February 2014, Fifth & Pacific sold Lucky Brands to private-equity firm Leonard Green & Partners for $225 million.

Finally, in February 2014, Fifth & Pacific was renamed Kate Spade and Company, with its only non-Spade brand being Adelington, a jewelry line that dates back to the J.C. Penney relationship.

The stock now trades as KATE, but if you pull up a chart, you’ll see a very long chart that encompasses the entire history of Liz Claiborne.

It’s not pretty, particularly the big collapse in 2009.

And the multiple name changes over the years mean that investors as a whole don’t love this company. In fact, they barely know it!

Shoppers, on the other hand, know very much what they like about Kate Spade, and they’d like to buy more of it.

So here’s my thesis.

Fashion goes in cycles.

A decade ago, Coach (COH) was the big dog in accessories. It was a great investment—but those days are gone.

Today, Michael Kors (KORS) is king of the hill, showing no sign of fatigue. Of course, that’s how it is at the top; everyone loves you. But someday, KORS will peak and I’m betting that KATE will be the next fashion favorite of investors.

The financial numbers are promising. Kate Spade (the entire company) saw revenues grow 21% to $1.26 billion in 2013. The loss for the year was 15 cents. But the fourth quarter was strong, bringing a profit of 15 cents (vs. four cents last year). So now, with the company free of the distractions of the past few years, and looking to expand rapidly in Asia—particularly China—upside potential is very good. Analysts are looking for earnings of $0.28 in 2014 and $0.64 in 2015.

Also good, and not to be underestimated, is the potential for perception among investors to improve, as they get a clearer understanding of Kate Spade’s new corporate structure.

Lastly, but not least, the stock’s momentum is strong, too, telling me this process is already under way.

So, you could just jump in and buy KATE here, but a more prudent course would be to wait for a little basing action, which might take the stock back down to 34.

Even smarter would be to become a regular reader of my Cabot Stock of the Month, so you can get my latest thoughts every week on ALL the stocks I’m recommending today. (I’ll tell you when to sell, too, and someday, that will be really important!) For details, click here.

Yours in pursuit of wisdom and wealth,

Timothy Lutts
Chief Analyst of Cabot Stock of the Month
Publisher, Cabot Wealth Advisory


Timothy Lutts can be found on Google Plus.

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