Stock Investment Tips Blog

Crocs (CROX) is the epitome of triumph and tragedy in the stock market.  AFter IPOing around $6.85 a share in February 2006, the stock began a meteoric rise in the fall of 2006, thanks to the rising popularity of its shoes. Its most famous shoes are a pair of rubber sandals with holes in them that are supposedly extremely comfortable. The shoes have since gained worldwide popularity.

Investors speculated the the fad would continue, and the stock continued to rise up to $75 a share in October 2007. Since then, its bubble has broken and CROX is now valued at less than 10% of what it was less than a year ago. On Friday, the stock closed just under $5.

I have been watching the CROX story off and on and it seemed like the epitome of what happens with asset bubbles. A perfectly decent asset, in this case a shoe company, becomes grossly overvalued, as owning the asset itself becomes a fad. The asset becomes so bloated with hot money that there’s no rational reason for its valuation. I thought about shorting the stock, but I never found the balls to do so.

What generally happens is that the asset quickly implodes, so much so that the asset goes below its fair market value. A good example is the tech bubble. While it was wise to sell tech in early 2000 at its insane valuations, it also made since to buy tech in early 2003 when tech stocks were sold too harshly.

I believed this was the case with CROX. After nosediving all the way down to about $6.70 a share, it had rebounded to about $9-$10 a share. It was trading at just a forward PE of 5 based on analyst estimates. I believed it was time to pile in, so I bought a lot of shares in the $9-$10 range.

The next day the management announces that it will be greatly missing its guidance and issued forward looking guidance. Instead of earnings of $1.56 for the year, Crocs expects to break even (in part due to a one time charge of $.13 a share for the closing of a plant). Revenues were guided down for the quarter from the $240-$250 million range to the $210-$220 million range.

Call me crazy, but I’m not willing to sell yet. While the revenue miss is disappointing, the sales are still there and the company is still cheap on a P/S ratio. I’m hoping Crocs will manage to boost its operating margins once it slims down its operations. I also think the company can maintain this amount of respectable sales since while its rubber shoe may be going out of style, the company now has many different types of footwear, and I think the company’s overall brand now is fairly strong.

One thing I’ll always remember from this incident is to take analyst estimates with a grain of salt. Buying mainly on an analyst forward PE is definitely not a mistake I’ll make again.

Disclaimer: Author still owns shares of Crocs (CROX).

Most articles give you tips on how you should invest. They may describe techniques of finding undervalued companies or encourage you to invest in stocks that you may know best. As for mutual funds and ETFs, they may encourage you to find ones with low fees and good management.

This is all well and good, but often, people’s mistakes in the market do not come out of failing to look for these goals. Often, people make bad investment mistakes for entirely other reasons. Most of the time, it is because these people get greedy and fearful and follow the herd. They avoid buying stocks that appear undervalued and instead buy stocks that are grossly overvalued because those stocks have been hot lately.

People’s cavemen instincts lead them to do what their friends and others are doing. It feels natural. Also, when things are looking horrible, they want to sell. Likewise, when stocks are running up and up, like they did in the late 20’s or like tech stocks did in the late 90’s, they want part of the action. This leads to people buying high and selling low.

While I’ve preached a lot about avoiding buying high and selling low in the past, it often falls on deaf ears. Many times, people don’t even realize they are following the crowd, when in fact, that is exactly what they are doing. Here are some tips to tell if you are making decisions that follow herd logic:

You make an investment because a lot of your friends are making a similar investment. While sometimes your friendship group may be onto something, often it is a sign that you all are following the herd and are buying late.

You react to how major newspapers categorize the market or the economy. By the time mainstream America thinks something is going to happen, it has long been priced into the market. For example, take the ‘recession’ that America supposedly went into the first quarter of 2008. By mid-March, when it was all over the news, the market had hit bottom. If you had sold out then, you would have missed out on an almost 8% up move in the market. 

3. Buying an asset class you are unfamiliar with. Many people got into real estate in 2005 and 2006 because of the amazing returns they heard other people got from flipping houses. These people were unfamiliar with the asset class, but got into it because other people were doing it. Now, in my opinion, many people are doing this with commodities, including energy ETFs.  In the late 90’s, many people were buying tech stocks even though they had no idea what the company really did or how it would ever be profitable.

The US housing market bubble has produced the present US financial crisis, affecting especially the stock market. This time, the crisis is believed to be the worst ever from other such crisis occurred since the World War II era. According to the financial experts, this crisis now marks an “end of an era of credit expansion based on the dollar as the international reserve currency”, which has lasted for over 60 years now.

The other financial crisis comprised of the nature of boom-bust processes. The boom-bust process usually center around credit and involves a misconception. This time, the easy credit generated demand that pushed up the value of the property beyond reasonable levels. People, armed with easy credit facilities, bought houses expecting that they could refinance their mortgage at a profit. This misconception, in turn, started a bubble.

The financial authorities stepped in every time the credit expansion ran into trouble. They threw in liquidity and attempted to stimulate the economy by expecting general public to believe that the financial problem has been solved effectively!

Also, globalization during the past decade allowed the United States to consume more than it produced by importing more goods. Thus, the US current account deficit reached a whooping 6.2 per cent of gross national product (GNP) in the year 2006. During the entire duration since globalization, the US financial institutions encouraged the US consumers to buy beyond their means through easier borrowings on generous terms. The regulations on financial aspects became nonexistent in recent years. Thus, a super-boom was created, leading to today’s financial crisis. The stock market is showing every sign of an economic slowdown and a looming recession.

The super-boom went out of control leading to a crisis, because the financial authorities were unable to calculate the risks and more-or-less, relied on the banks’ risk management methods. Many other factors plunged the US economy and the stock markets into deeper troubles.

The crisis began with the subprime mortgages and spread to collateralized debt obligations, this in turn endangered municipal and mortgage insurance and reinsurance companies, and threatened to unravel the multi-trillion-dollar credit market.

Investment banks’ commitments to leveraged buyouts became liabilities. Market-neutral hedge funds turned out not to be market-neutral and had to be unwound. The terminal blow came when interbank lending, which is the heart of the financial system, was disrupted. The central banks had to put in an unexampled amount of money and extend credit. That made the crisis graver than any since the World War II.

The power of the financial authorities to energize the economy is constrained by the unwillingness of the rest of the world to amass additional dollar reserves. Until recently, investors were trusting that the US Federal Reserve would do whatsoever it needs to do to avoid a recession, since that is what it exercised on past occasions. Now they’ll have to realize that the Fed may no more is in a position to do so. With oil, food and other commodities, the Fed also is concerned of inflation.

It seems that the pivotal role played by the United States stock markets for over 5 decades is being severely challenged by some of the growing Asian economies, especially China, and will take many years for the United States to get back on top.