Why Michael Kors Isn’t the Growth Juggernaut It Appears to Be

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Michael Kors (NYSE:KORS) has quickly become a short sellers’ favorite after being a darling of Wall Street for the past couple of years. The company has a popular brand that allows it to sell accessories at huge mark-ups, and this combination has led to the company growing its sales very rapidly — at more than 50 percent annualized rate – while generating strong profit margins of 17 percent.

While the company’s profit margins have been declining, the company’s earnings have been rising fast enough so that the stock looks cheap at just 24 times trailing earnings and at just 19 times next year’s estimated profits.

Why, then, has the stock quickly fallen from $90 per share to $80 per share, and is this an opportunity or a value trap?

There have certainly been some minor signs that the company’s profit growth is decelerating, but then again, it could not realistically grow its profits over 50 percent per year forever. Given this profit growth deceleration, we could be seeing some momentum players abandon the stock. If that’s the case, then Michael Kors is a stock that trades at 19 times next year’s earnings with a greater than 20 percent growth rate, and this seems cheap.

So why, then, hasn’t the “smart money” picked up on this? It could be that something else is going on.

One theory is that management is putting items on sales near the end of the quarter to ensure that the company meets its sales figures. While this may not be in shareholders’ best interest, this is not an uncommon practice. Executives at companies such as Michael Kors are under a great deal of pressure to meet Wall Street estimates. Their salaries, which are often based heavily in stock, and their jobs depend on it.

There are good intentions behind this approach. We want management’s interest to be aligned with shareholders’ interests because otherwise management is in a position to rob shareholders though negligence or outright theft. But there is a downside to this, too: Executives will do whatever it takes to meet Wall Street estimates, and while they may not lie, they may do things that skew the results.

So one reason hedge funds and activist investors may not be jumping at the opportunity is that they believe something to this effect is taking place, and this means that Michael Kors isn’t the growth juggernaut that it appears to be. In that case, what should investors do?

With growth stocks such as these, I think you are better safe than sorry, and I simply wouldn’t risk it. Even if the growth is still there, it seems that a lot of shareholders are jumping ship. This means that short sellers are piling on and the stock won’t be appealing until the deep value investors ship in, and this could be at a much lower price.

Furthermore, we have to realize that with very few exceptions, brand loyalty is fickle. Fashions are changing constantly, and while we can point to Nike (NYSE:NKE) or Coca-Cola (NYSE:KO) as brands that have withstood the test of time, we can also point to hundreds, even thousands more, that have not.

With this in mind, I would stay away from Michael Kors at this point in time. The worst that can happen is that you miss a great value opportunity. But just keep in mind that there are plenty of these out there, and you’re better off finding one that is safe and reliable, as well.

Disclosure: Ben Kramer-Miller has no position in Michael Kors.

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