Short-term traders love fad stocks. The public’s temporary infatuation with a hot product often causes investors to turn a blind eye to basic stock fundamentals, which often causes big rallies that can translate into big profits for traders. However, long-term investors should be wary of top-heavy fad stocks, which could unexpectedly fall off a cliff once the public tires of a product, or if it becomes commoditized through imitation.
Yet what defines a “fad stock”? How can investors separate a good product with staying power from those that will fade away? Let’s take a look at three “fad” footwear stocks – two of which I consider to be weaker than the other – to better understand how fad stocks can stabilize and keep growing.
Mention “fad” and “footwear” in the same sentence and most investors will immediately think of.
The creator of those polarizing, hole-filled Croslite (proprietary foam resin) shoes was once a Wall Street darling, peaking at nearly $70 per share in 2007. However, the financial crisis dealt Crocs, Inc. (NASDAQ:CROX) a near fatal blow that it has yet to fully recover from. Although its shares have since recovered from its crisis low of $1 per share, analysts are still divided regarding the company’s future.
Crocs, Inc. (NASDAQ:CROX)’s first quarter results, however, definitely favored the bulls. At the end of April, the company reported adjusted earnings per share of $0.35, a 12.9% increase from the prior year quarter. Revenue also climbed 14.68% to $311.7 million. Analysts had expected Crocs, Inc. (NASDAQ:CROX) to earn $0.34 per share on revenue of $305.08 million.
Crocs, Inc. (NASDAQ:CROX) attributed its strong top and bottom-line performance to strong sales of its spring and summer product lines. Since 2007, Crocs, Inc. (NASDAQ:CROX) notably diversified away from its core Crocs, Inc. (NASDAQ:CROX) line into sportier alternatives, such as sneakers, boots, beach shoes, heels and sandals, which are all created with its Croslite resin. Crocs, Inc. (NASDAQ:CROX) reported that strong growth in Asia, which accounted for 41% of the company’s 2012 revenue, will continue to boost its top line throughout 2013. By comparison, Crocs generated 44% of its 2012 sales from the Americas.
Yet Crocs’ margins slightly edged lower, with gross margin dropping from 53.3% to 53.2%. SG&A expenses (selling, general and administrative) rose 22.9% as the company spent more heavily on new store openings, marketing and promotions.
Crocs’ cyclical revenue growth, which appears to be the strongest during the summer, looks promising, but constantly rising expenses and flat margins could lead to flat or declining bottom-line growth in the near future, which generates the majority of its revenue from its popular UGG sheepskin boots, is regarded as another fad stock by many investors. The business is extremely top heavy, with 65% of its first quarter top line generated by UGG boots alone – down from 96% during the winter fourth quarter. This means that any weather impacts, such as unseasonably hot winters, will take a bite out of yearly sales. In addition, UGG boots, which originally come from Australia, have been a fashion trend since the 1990s, which means that demand could wane as new fashion trends emerge.