Michael Kors +21.5%, and why value investing is so hard

Overnight (I reside in Asia), Michael Kors (KORS US) announced an above-expectation fiscal 1Q18 result, which sent the stock up 21.5% to US$45.25. Comp sales still declined by about 5-6% YoY, but this was better than the c10% decline the market was expecting. Earnings declined by about 20% YoY as operating margins fell from about 18% to 15%, but EPS declines were only in the mid single digits, because the company has bought back so many shares over the past 12 months at such low prices (the stock has been trading at 5x EBITDA and a mid-teen FCF yield for most the past 12mths).

KORS 3Q result no kors for concern

The LT3000 Blog got off to a seemingly inauspicious start by posting a long thesis on KORS a day before the company’s 3Q result came in short expectations, sending the stock down as much as 15% intra-day (10% by the close). I increased my position by 50% at close to the daily lows of $35, reducing my average in to US$39, and increasing the position size to 25bp of the fund. The stock is trading up today early in the session at US$38, against a weak broader market, so my position is only marginally underwater at present.

The 3Q result itself was actually broadly in line with expectations. While headline sales and operating margins were down YoY, this was already baked into guidance/estimates. Comp sales declined slightly faster than expected (6-7%, vs. 5-6% expectations), but quarterly earnings actually beat street estimates by a penny. The real issue was weaker 4Q outlook commentary, where the company guided for an accelerated low-teen decline in comp sales in 4Q, and reduced its 2017 fiscal EPS guidance from about US$4.40 to about US$4.20.

Michael Kors is out of fashion

I recently initiated a 20bp position in Michael Kors (KORS US @ $41.09) – the global luxury goods company run (Chief Creative Director) by its eponymous founder. My entire research process took less than an hour, and illustrates nicely one of the investment philosophies I have developed over the years – that more information does not necessarily lead to better decisions or better investment outcomes. One doesn’t have to know everything or even a lot to make money in markets in my view – only what is important. Indeed, it is arguable that being able to block out irrelevant noise is equally essential.

First things first – KORS screens very well using Joel Greenblatt’s ‘magic formula’ – the stock is trading on a 9x trailing PE ratio, and generates an extremely high ROE of approximately 40-50%. Indeed, the stock screens in the top 5% of companies in the S&P500 on this measure. Greenblatt has argued that a mechanical quantitative approach to buying stocks that screen well on these two combined metrics – using earnings yield as a proxy for ‘cheapness’, and ROE as a proxy for ‘quality’ – has historically trounced the market. It is always comforting to know, when selecting your preferred bottom up picks, that you are selecting from a pool of potential opportunities where the odds are likely skewed in your favour. That certainly does not guarantee a good outcome, but it does increase the probability of one materially.