Trader’s Narrative

Although I was early, my skepticism about the growth story of Crocs (CROX) turned out to be right on the money.

The dream turned into a nightmare for the longs with an almost 40% gap down on November 1st 2007. Although it would have been very painful, the best option - in hindsight - would have been to sell right there and then.

That’s because when Wall St. turns on a one time growth darling… it can get very ugly.

Double Whammy
For one, no growth investor or swing trader wants to ride along with management when they were either blindsided by a slowdown or saw it coming and were coy and didn’t communicate it in advance.

As well, declining sales/growth reduces the valuation of a company. And it has the levered effect of also reducing the multiple used to value it: the price earnings ratio. So the company is hit with a double whammy.

Very few are able to recover from this. That’s why it is dangerous to fall in love with a stock, no matter how persuasive the arguments. A stock is a stock is a stock.

But with Crocs, I was a bit puzzled at how people could actually could like them, never mind love them (as a product or a stock). In any case, now that the whole sorry saga has played out, here’s the chart:

Other than the obvious line break (blue) that spelled the end of the run, it is interesting that each gap down was below the previous swing low. What more obvious sign that buyers were simply not showing up?

In other words, in each subsequent price realignment, it missed previously established support levels. Until finally, it is now trading below the first double bottom in 2006.

It is safe to say almost all longs are now underwater and unhappy. Which means that if a miracle delivers a rally, they will be so relieved to be able to get out with any semblance of break even, it will be a short lived rally.

Other than running away from former growth stock darlings, Crocs has other useful lessons. Study the first few months of CROX and notice how it built a base from which it launched a massive run. It almost looks like two back to back cup and handle formations. Now go and find stocks which have similar bases. IPOs are great candidates for growth but they are few and far in between these days.

At the end of June I wrote about Crocs (CROX) and Heelys (HLYS), two faddish shoe companies that I didn’t think had any longevity.

Back then Crocs’ shares were in the low $40’s and Heelys were in the mid $20’s (red arrows below). Heelys’ chart looked much worse as it was in a clear downtrend and had just fallen through intermediate support. Not surprisingly it fared worst among the two. Today it closed at $6.19 a share.

Crocs fared better as it rose to a high of $75 but since then it has fallen to the high $30’s. The damage is in the broken uptrend:

Even Maddox got in on the action and landed a few punches. As you’d expect, insiders have been selling like crazy. The insider selling wasn’t a tipoff since anytime you have a huge runup, insiders can’t resist taking free money. The actual tipoff was that the product is a fad and offers no real benefits which competitors can not emulate at a much cheaper price.

Here’s a tale of two shoe companies: one is an injection moulded clog with holes while the other is a children’s sneaker with a wheel embeded in the heel.

Both sound a little ridiculous but both are public companies based on only that one product line. But beyond being a fad, the two companies part ways. While Crocs (CROX) has become a darling of the mo-mo crowd, Heelys (HLYS) slumped to an all time low yesterday.

Of course, companies based on only one fad product are nothing new to Wall Street. Bowling alleys, drive in movie theatres, cabbage patch kids, Pokemon, etc. The list is long (much longer than my patience to mention them all).

Crocs and Heelys have different things to worry about though. While having a wheel embedded in your heel might sound ‘cool’ (if I was 11 years old), the status of ‘cool’ is so ephemeral that you can’t build a company around it. Certainly not one based on one product. Crocs on the other hand isn’t about being ‘cool’ as much as practicality and comfort. So there’s some longevity there.

But their problem is that their margins are unsustainable. Just a week ago my brother picked up a pair of immitation Crocs for $5. Had he bought genuine Crocs, the pair would have run him around $50. The really scary thing is I can’t really see a difference between them. The Chinese have a knack for imitation (and capitalism). I wouldn’t be surprised if

Now, I’m not really a fundymentalist investor (I only play one on the net sometimes) but I can’t see how Crocs will come out of this in one piece. They can’t really branch into other products - after all, that’s what they are known for. That’s their brand. And who would want to buy a t-shirt or pants from Crocs? Maybe if they were injection moulded t-shirts and pants.

This reminds me of Krispy Kreme (KKD). Remember them? In the aftermath of the bubble they came public with one product: donuts. But these weren’t regular donuts. Oh no. We were told that these were manna from heaven. Glazed with the very nectar of the Gods. They were baked fresh in each store. Right in front of your eyes on these conveyor belts while you watched! How else to explain the crazy valuation?

The stock zoomed almost fivefold from $10 at IPO to a high of $49.74. Then it came back to earth. Right now it is around $10 again. Turns out it wasn’t mana but regular dough and sugar. My point is that valuation does matter but it may take time to kick in.

Crocs
Market Cap: $3 billion
Price/Sales: 7.6
Profit Margin: 18%
Short Ratio: 3

Heelys
Market Cap: $600 million
Price/Sales: 3.0
Profit Margin: 16%
Short Ratio: 14