Athletic apparel company Skechers (NYSE:SKX) dropped the ball on second-quarter results, and investors dropped SKX stock in response. After the company reported weaker than expected comparable sales growth and profits, and delivered a weaker than expected third-quarter guide, SKX stock dropped more than 20%.

That is a big move lower.

But, the results weren’t “down 20% bad.” And, SKX stock is really cheap trading in the mid-$20’s.

As such, I think this sell-off presents a golden buying opportunity for dip buyers. Even considering the recent ugly quarter, I think SKX stock is worth near $40, meaning that the present mid-$20’s price tag is just nonsensical.

Here’s a deeper look.

Skechers Q2 Report Is A Swing … And A Miss

Admittedly, Skechers’ second-quarter earnings report was not very good.

Sales growth decelerated from a historical run-rate of around 16% to just over 10%. The slowdown was the result of the domestic wholesale business going negative, which is a problem that has plagued this company before. Moreover, management continues to spend an arm and a leg to fuel robust international growth. The operating expense rate rose 200 basis points in the quarter, leading to a harsh decline in operating margins and a 20%-plus year-over-year drop in net profits.

Looking forward, it looks like management expects to keep spending big. The third-quarter earnings guide was really weak, missing consensus expectations by more than 20%.

Those aren’t pretty numbers.

But, on the plus side, the international business remains red-hot, growing at a 25% clip in Q2. The company-owned business is also doing well globally (comparable sales +4.5%) and in the U.S. (comparable sales +2.2%). Gross margins were up 180 basis points in the quarter due to international business strength.

And, even if Skechers does drop the ball on Q4 earnings, too, the company should be able to do about $1.70 in earnings-per-share. That means that SKX stock, at $25, is trading at under 15-times a low-ball estimate for this year’s earnings.

In the big picture, then, you have a stock that is really cheap and getting whacked because of a domestic sales slowdown and margin pressures. But, the international business is red-hot, and the margin pressures are from management spending too much, not from structural problems (gross margins are actually up). Thus, at present valuation levels, risks seem overstated and rewards seem undervalued.

Skechers Stock Is Way Undervalued

In the $25 range, SKX stock is way undervalued.

The sales slowdown in the U.S. and globally doesn’t really bother me. I was never really predicting 10-15% or higher revenue growth rates for Skechers. Instead, I always knew that the domestic business would slow, and that overall revenue growth over the next five years would shake out in the 5-10% range.

The higher spend does concern me some. But, in the bigger picture, gross margins are trending higher and that is what matters. Once Skechers stops expanding aggressively in international markets, the operating expense rate will come back down (it is going up right now due to higher international advertising spend, investments into direct-to-consumer, and more international store openings, all of which should moderate as expansion slows).

Thus, in the long-term, gross margins should trend slightly higher from today’s 48% rate. Meanwhile, the operating expense rate will drop back from today’s near 39% rate. My best guess is that in five years, this is a 49% gross margin and 37% expense rate business.

Putting it all together, 5-10% revenue growth and 12% operating margins leads me to believe that Skechers can earn about $3.50 in EPS in five years. A market-average 16X forward multiple on $3.50 implies a four-year forward price target of $56. Discounted back by 10%-per-year, that equates to a present-day value of just under $40.

Bottom Line on SKX Stock

The recent sell-off in SKX stock is way overdone. Domestic company owned sales growth remains healthy. The international business remains red hot. Gross margins are trending up. And the expense rate, which is currently inflated due to international expansion, will come down once expansion stops.

Add it all up, and there is no reason this 10% revenue growth company with healthy margin drivers should be trading at such an anemic valuation. Realistically, I think SKX stock is worth around $40 today. That implies a ton of upside from today’s $25 price tag.

As of this writing, Luke Lango was long SKX.

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