by Will Ashworth | March 22, 2012 10:33 am
CNBC commentator Herb Greenberg wrote on March 1 that a speculative frenzy is upon us. Greenberg believes stock valuations have gotten out of hand, and he points to retailers Fossil (NASDAQ:FOSL) and Tiffany (NYSE:TIF) as examples.
Fossil, with annual revenue of $2.5 billion, currently has a market cap of $8.2 billion, while Tiffany has a market cap of around $9.3 billion on $3.5 billion in revenue. On the surface, Greenberg’s argument doesn’t hold water; Tiffany’s revenues and market cap are both 40% higher than Fossil’s. However, upon closer examination, I think you’ll see that his argument makes some sense.
Greenberg tends to get a bad rap — too pessimistic, many will suggest. But I can tell you from firsthand experience that he has a nose for smelly situations.
Over a decade ago, I owned some shares (a tiny part of my portfolio, thank goodness) in ACLN, a Belgium-based, Cyprus-incorporated shipper of new and used cars to Africa from Europe. By December 1999, the company was generating $100 million in revenue, operating $24 million in profits and net earnings of $2.62 a share. By September 2001, it went from a market cap of a few million to $700 million.
Greenberg kept after the story, convinced that the entire business was a house of cards. It turned out he was 100% correct. So when Greenberg makes a statement about valuations, there’s usually rational thought behind it.
For every argument you can make about why Fossil is reasonably priced, there’s a counter-argument for why it isn’t — and that’s the beauty of investing. For me, Fossil seems expensive for the following reasons:
Tiffany’s gross margin is 59%, 290 basis points higher than Fossil’s, and its operating margin is 19.4%, 100 basis points higher. While margins don’t necessarily tell the whole story, the difference is meaningful when looked at side by side.
Since Greenberg was comparing revenues of the two companies in his valuation assessment, P-S seems like a good metric to use. On this front, Tiffany trades at 2.62 times sales, versus 3.14 for Fossil.
Although Tiffany is primarily direct-to-consumer, while Fossil is more wholesale, the two businesses are still directly comparable. EV/EBITDA is generally the metric I use when making a quick assessment of a stock’s relative value.
Although I don’t like to see the multiple higher than 10, I will make an exception if the brand is strong and sales/earnings are growing. Tiffany’s enterprise value is 10.9 times EBITDA, versus 14.9 times for Fossil.
This means investors are currently willing to pay 40% more for Fossil’s EBITDA earnings. Put another way, Tiffany’s EBITDA margin is 21% higher than Fossil’s 25.5%. As Fossil continues to wade into direct-to-consumer retail, it will have to keep an eye on its margins.
On this metric there’s no comparison. According to RetailSails.com, Fossil’s 2011 sales per square foot at its U.S. stores was $807. Tiffany’s sales per square foot were almost four times greater at $3,085. Only Apple (NASDAQ:AAPL) has higher productivity.
Clearly, selling expensive jewelery can’t be compared with selling inexpensive watches and accessories. However, sales per square foot is an important metric in that both stores are comparably productive, yet Fossil gets a more generous valuation. While retailers generally don’t reveal them, it would be interesting to know the conversion ratio (the number of customers buying based on traffic into the store) at each store. Obviously, Fossil’s would be much higher. The question is by how much.
Fossil is definitely the faster-growing company. Investors who own its stock obviously feel O.K. about paying up for this growth. What Greenberg was pointing out is that stock valuations in many instances have lost their basis in reality.
Using the S&P 500 as a proxy, I’m not convinced. S&P 500 earnings in 2012 are projected to reach $104.40 a share — the highest level ever. As a result, the P-E ratio for the index continues to drop.
Where Greenberg gets it right is in homing in on specific stocks, such as Fossil. Over the past five years, Fossil has achieved an annual return of 38%. If corporate earnings generally, and Fossil specifically, don’t keep pace, the stock has nowhere to go but down.
Tiffany, on the other hand, achieves moderate growth in both earnings and total return. What this tells me is that investors are currently willing to buy serious growth and serious value. Tiffany, unfortunately, is stuck in the middle.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.
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