Under Armor (UA) is a growth stock in a non-growth market. Sports apparel and footwear have a limited market size that can only grow so far, yet this stock has shown robust top-line growth that has pleased growth investors who have held the stock for a long time.
UA did not disappoint this quarter, with EPS beating by a penny and revenue growth of 34% that shows demand for the company’s products are expanding. The company also showed strong growth in each of its constituent operations; apparel net revenues rose 35% year-over-year, footwear rose 34%, and accessories were up 18%.
This is the more important growth for UA currently, although gross margins are rising and guidance for operating income seems healthy. Now investors are not particularly worried about UA growing its margins, but it will become an increasingly bigger concern when revenue growth slows.
The big, and unanswerable, question is when that revenue growth will slow. Last year, year-over-year revenue growth was up 36%, and it rose 35% the quarter before that. In 2013 Q3, the company’s revenue grew only 26% and Q2 rose only 23%. This means that we are now in the third quarter of a stable growth of the business after it began to accelerate.
That quarter of acceleration showed a major move in the stock, going from over $42 to $54 overnight, and the stock only rose higher even after a correction that all growth stocks suffered in April and May. As the stock soars again, the question is whether its current P/E ratio of 89 is too high.
It’s important to remember that a high P/E ratio was the argument for bears in January, who said the stock was much too expensive relative to Nike (NKE), which is flat for the year despite its P/E ratio of 26. The lesson here is obvious: P/E ratios are not enough to go by when deciding if a stock is too expensive or too cheap.
The reason for this makes sense; a lot of investors are willing to pay a discount rate for future growth. They will pay a higher P/E ratio for UA now because its earnings will grow steadily as its revenues rise until it eventually matures at the ±26 range that NKE has stayed around. Then they may hold for value or sell off and look for another growth stock to bet on.
The high price of UA is part of the high price that growth investors pay for top-line growth. Growth is hard to find and there are a lot of investors looking for it, so it makes sense that growth would itself be expensive—hence the high P/E ratio. Those who were willing to tolerate a high P/E ratio two days ago with UA saw their holdings grow a healthy amount today; those who fear pricey momentum stocks did not.
This is the crux of growth versus value investing: growth investors will pay a lot for growth if they think that “a lot” still isn’t as much as the growth is truly worth over a certain time horizon. If the market’s estimate of the value of UA’s growth is below the actual growth that UA posts in its earnings reports, there is money to be made by buying the company’s stock. Those who understood UA’s business, its market position, and its potential realized that and bet on the stock early in the year. Those holdings are up over 50% now. Others who feared the high risk of a pricey stock and stayed with NKE have seen zero growth, as that name underperformed the broader market on low growth.