Thursday, May 20, 2010

Rule #1 Analysis on True Religion

As promised, I'm going to show you guys what I came up with in my Rule #1 analysis on True Religion (Ticker: TRLG).  Click on that link and you'll be able to download the analysis.  Be sure to take a read of my post on Rule #1 Analysis itself before reading this post.

The Big 5
The first few tabs are simply data that I copy and pasted from MSN Money.  If you are interested in the raw data, be my guest and dive right in.  However the good stuff is in the "Big 5" tab.  At the very top of that sheet, you will see a "Summary" table.  This gives you the 9-year average, 5-year average, and last year's ROIC, sales growth, EPS growth, BVPS growth, and free cash flow growth.  Phil Town tells us that we are really interested in the 9-year average of these numbers.  Why?  Simply because it tells us if the company has been consistently growing.  So why display the 5-year and 1-year numbers?  Those are useful because we may be able to spot an undesirable trend if one is there. For example, the growth of the company may have been good 7-10 years ago, but it's been doing poorly for the past few years.

So, what do we have for True Religion?  First off, we have a whole bunch of "Invalid Data" for the 9-year numbers.  This is simply due to the fact that True Religion hasn't been around that long as a public company!  Switch over to any of the raw data tabs and you will see that there's only 8 years worth of data.  Is that a problem?  It could be...if your company just turned public last year and had a superb year, that doesn't tell you too much.  It could have been a fluke that it did well.  What about True Religion's case?  Qualitatively, it's an amazing brand and from my reading of its Form 10-K, its future prospects don't look too bad either.  Let's look at its 5-year numbers instead.  They are simply stellar!  Phil Town recommends that all of these numbers be 10% or higher.  True Religion's numbers range from 21.1% to 85.2%!  Great growth story all-around!

But wait, you say.  Last year's growth wasn't that good.  Its EPS only grew by 4.9%.  Should we be concerned?  Let's consider this: in 2008 and 2009, we saw the worst recession to hit the global economy since the Great Depression, and you are concerned that True Religion "only" grew its EPS by 4.9%?  Are you kidding me?  The company did very well in such a difficult environment!  So, I give it an "A" for its 2009 performance!

Lastly, we want to make sure that the company isn't sinking in debt.  What do we see here?  From the cash flow generated in 2009, it would take True Religion exactly 0 years to pay off its debt, because it has no debt!  Typically, we want the duration to be 3 years or less, but in our case, we have not a thing to worry about!

So, all-in-all, True Religion did great in the Big 5s.  Coupled with my quick analysis from the Form 10-K, I think we have a fairly solid company on our hands.  Of course, I have done more than just reading the Form 10-K and running the Rule #1 spreadsheet (and so should you if you decide to invest in it), but this is a great start!

When to Get In
So, now that we've established that True Religion is a solid company, does it mean that we quickly log onto our brokerage website and start placing orders for the stock?  Absolutely not!  We need to know if True Religion is priced at a good value.  If it's too expensive, even though a company may have a bright future, we must not buy the stock, for the lack of a margin of safety.

Go ahead and click on the "Sticker Price" tab.  Here, you will see some numbers involving earnings per share (EPS), book value per share (BVPS), Price/Earnings ratio (PE), etc.  These are numbers that help us generate what we think the intrinsic value (or sticker price) of the stock is.

First, we need to estimate the rate at which the company will grow in the next few years.  The "Estimated EPS Growth" number is pulled from the analysts' estimates.  The "Historical BVPS Growth" is the smallest yearly BVPS gain in the last 9 years.  We want to be conservative, so the spreadsheet takes the minimum of these 2 numbers.  If you don't want to use either of these 2 numbers, go ahead an type in what you think is right in the "User Input Growth" box.  Here, I have left it blank because I thought the estimated EPS growth number was fairly good.

Next, we need to figure out at what P/E ratio we expect the stock to trade in the future.  The "Historical PE" is the lowest average P/E ratio in the last 3 years.  The "PE from EPS Growth" number is simply double of what the estimated EPS growth number is, because it is typical for a company to trade at a P/E ratio double the rate at which its EPS is growing.  Again, the spreadsheet will take the minimum of these 2 numbers by default.  However, I have input 15.0 as the P/E ratio that I would like to use.  This is because a P/E ratio of 9.8 is simply too low for such a growth stock. Yet, a P/E of 49 seems a little too high.  Thus, I have chosen 15.0, which is slightly higher than the historical average P/E ratio of the S&P 500.

Finally, after using a magical formula, we arrive at the sticker price of $64.36.  Based on the numbers above, the intrinsic value of True Religion is $64.36 per share.  Phil Town recommends a safety margin of 50%.  So, we don't want to buy unless it's trading at or below the "Entry Price", which is $32.18.  This gives us a nice cushion in case our analysis was horribly wrong.  Today, True Religion closed at $28.06.  Congratulations, you are cleared to buy the stock (except, of course, if the stock jumps more than $4.12 tomorrow at the market open)!

Now That We're In, When to Get Out
Selling is often the toughest thing an investor can do.  It's difficult to sell in any case.  If you're down, you want to avoid booking a loss and end up not selling.  If you're up, you can be afraid that once you sell the stock, it shoots up even more.  However, one thing we do know is that the market is emotional.  Today, the market doesn't like True Religion much, as evident by how undervalued it is.  5 years from now, the market may be overly optimistic about the company.  Chances are, if our analysis is correct, the stock price will rise to its intrinsic value, or sticker price.  It may even rise higher than the sticker price for all we know.

So, it's not a bad idea to use the sticker price as a target, but know that when the stock is on a roll, it could go well beyond that price.  But a word of caution: it can drop to $20 tomorrow as well!  But if the fundamentals of the company have not changed, it merely means that you should buy more of the stock because it's a better deal.  I recently bought Phil Town's new book, Payback Time.  I haven't read it yet as it's in my reading queue, but it essentially talks about stockpiling a stock (i.e. buying more as the price drops).  We shall see what he has to say.  In any case, the topic of when to sell can well take up a few posts.  So, I will leave that for a future discussion.  For those of you in Canada, have a happy Victoria Day long weekend!