Shares of Garmin (NYSE:GRMN) soared higher on Wednesday, Feb. 20, after the wearable and GPS technology company reported robust fourth-quarter numbers, which beat both top- and bottom-line expectations. Management also issued a strong fiscal 2019 guide which impressed on both the revenue and profit lines too. Investors rallied around the strong, double-beat-and-raise report, and Garmin stock popped more than 15% in response to new decade highs.
This rally, however, appears to be overdone. Up above $80, Garmin stock is simply overvalued.
The fundamentals here are good. They are also improving. Garmin is clearly turning into an action market technology powerhouse with broad reach across multiple sectors. This has, still does, and will continue to power healthy revenue growth, margin expansion and profit growth at the company.
But the growth potential here isn’t that big. The wearables market is growing, but it’s a slow-growth market. Most of Garmin’s business is growing by 10%-plus, but the company’s historically largest business, auto, is in secular decline. Margins are moving higher, but they are expected to take a step back next year. Profits are marching higher too, but earnings-per-share growth next year is expected to be flat.
Overall, Garmin is supported by good, but not great, growth fundamentals. Above $80, Garmin stock is priced for great, not good, growth. Eventually, this divergence will catch up to Garmin stock, and will result in shares crashing back to more reasonable valuation levels.
Garmin’s Growth Potential Is Good, Not Great
With Garmin, investors have a solid company that is clearly transforming into an action market technology powerhouse. From fitness and outdoor smartwatches to smart bikes to action cameras to GPS-infused technologies, Garmin provides consumer technology accessories for any and every active individual in the world.
This is a favorable position. The number of active individuals in the world is on the rise given secular trends towards healthier and more active lifestyles. Also, the volume of connected devices in the fitness and action market worlds is only growing with the mainstream emergence of the IoT market. Demand for connected devices across this whole industry will consequently remain on a secular uptrend. Also, because of product diversity, Garmin isn’t subject to big hits on big fashion/style swings.
Overall, the growth profile is good… but it’s far from great.
The whole wearables market is projected as an 11% annualized growth market over the next several years. Garmin’s growth is below that, due to Apple (NASDAQ:AAPL) winning the lion’s share of the market. Revenue growth last year was 7%. It was 4% last quarter. Next year, revenue growth is expected to be below 5%. Thus, going forward, this is likely a steady, low- to mid-single-digit revenue growth company. That’s good, but a far stretch from great.
Meanwhile, margins have been on a consistent uptrend for the past several years, and exited 2018 with momentum. But, they are expected to take a slight step back in 2019, with operating margins guided to fall 60 basis points year over year. Also, this drop in margins is happening while operating margins are nearing their multi-year highs of 24%. Thus, the most likely path forward for margins is higher, but not by much. Again, that’s good, but a far stretch from great.
Broadly speaking, the growth narrative here is good, not great. That’s bad news for Garmin stock, which is currently priced for great, not good.
The Valuation Implies Great
Garmin stock currently trades hands at $83. EPS in fiscal 2019 is guided at $3.70. Thus, this stock is trading at 22.4 times forward earnings.
That big multiple doesn’t make sense next to this company’s growth profile. As stated earlier, this is a low- to mid-single-digit revenue growth company with some margin expansion potential. Put together, that implies around mid- to high-single-digit earnings growth potential. At best, it implies ~10% earnings growth potential.
A 20-plus forward multiple on a ~10% earnings growth stock doesn’t compute. The market is trading at 16x forward earnings for what analysts see as mid-teens earnings growth over the next several years. On other words, Garmin stock is trading at a bigger multiple than the market, but has lower growth prospects. That’s a recipe for disaster.
Inevitably, this divergence between valuation and fundamentals will catch up to Garmin stock. When it does, this stock will fall back to reality.
Bottom Line on GRMN Stock
When it comes to Garmin stock trading above $80, valuation is a tough pill to swallow. Put simply, you have a good growth company trading at a great growth valuation. That divergence is unsustainable. Eventually, it will correct itself. When it does, Garmin stock will drop.
As of this writing, Luke Lango was long AAPL.
