- Despite a price correction in April, Under Armour is still trading at a high P/S ratio.
- What caused the correction, and will it happen again?.
- What’s the best way to invest in a hyper-growth stock like this?.
Even an experienced investor can find it daunting when dealing with a hyper-growth stock that’s already showing signs of volatility. Despite tumbling from $46 to $40 levels after its last quarter earnings call, Under Armour (NYSE:UA) stock still seems to be the market’s darling.
UA has been one of few companies that has shown unfaltering growth for nearly two decades, so it’s natural that expectations remain high. However, the market doesn’t seem to appreciate the fact that the price has not yet fully corrected. The April share price fall was only the first signs that rapid growth cannot be a continuous phenomenon - at least, not once the company has reached the scale that Under Armour has.
In spite of the correction, Under Armour continues to trade at a forward P/E of nearly 50. The problem is, it’s trading at a 4.2 P/S ratio. That looks fine for a high-growth company but, as it gets bigger, it will likely fall in line with that of Nike, which is currently around 3.1.
Where’s the Growth Going to Come From?
This is not to say that their growth prospects are fizzling out. Far from it: even after hitting nearly $4 billion in 2015, Under Armour still hasn’t fully penetrated its home market, let alone emerging ones like China and India. The former’s contribution to international revenues stands at 56%, but for UA that’s still a very young market. And they haven’t even opened up to India yet.
Under Armour CEO Kevin Plank at the Q1 2016 Earnings Call:
“Let's focus on how and where we are transforming and driving our brand. The first example is in China, where we have patiently built the foundation we know is needed to capture the enormous growth opportunity in that market. In this past quarter, we earned more revenue in China in 90 days than we did in the full year of 2014. We have grown judiciously in this critical market, building a solid foundation of core product, with plans to add an additional 120 owned and partner brand health stores in Greater China throughout 2016.”
And the reason for the stock price drop just after the first quarter’s earnings was released? Weak guidance, nothing more. Here’s how Bloomberg reported it:
“The company forecast that its gross margin will narrow by 100 basis points, hurt in part by the strong dollar. It expects 2016 sales to climb about 25 percent, with operating income rising 23 percent.”
On that weaker-than-normal guidance alone, the stock has lost 13%. It just shows the risks of being so highly valued. The market is still expectant, but perhaps not to that great a degree.
Invest or Not?
The fact of the matter is that UA still has a pretty long runway to keep its top line growth intact. Emerging markets present ample opportunity for expansion, and they’ve already proved their mettle against Adidas in the United States. Nike may still be far away, but it’s just a matter of time before UA is close on their heels.
Their growth plan towards the $8 billion mark has already been laid out clearly for investors to see, and emerging markets are integral to that plan.
With such high P/S and forward P/E ratios, this stock is not for short-term investors. If you’re willing to go long term, then the best way to invest is to dollar-cost average your way into a position that is built slowly over time.
The company is bound to go through more guidance or earnings shocks over the coming quarters, and that’s going to continue to happen until the price corrects itself closer to what Nike’s relatively stable business trades at. It might not be fair to expect UA to keep growing at the same pace it did when it was a $400 million company, but that’s the way the market rolls until reality hits.
And when it does, that’s your chance to buy in. If dollar-cost averaging isn’t your investment style, then wait for the shocks to hit the stock before you put your money in. In the long run, this company may well grow into its current valuation, but don’t be hasty.