Watch for the Explosion: A Short Analysis on True Religion

In a previous post, I talked about what a great find True Religion (ticker: TRLG) was.  For those of you unfamiliar with the brand, it makes high-end jeans that are worn by many Hollywood celebrities.  Two weeks ago (April 12, 2010), I decided that I was going to be a shareholder of this company.  What attracted me to the stock was its growth potential.  This post will focus on primarily looking through a company's annual report to see what management has in store.

What's in an Annual Report?
An annual report, similar to quarterly reports, is a document that is required by the SEC for all public companies to be submitted on an annual basis.  It is called the Form 10-K.  It contains information such as the business, its direction, risks, etc.  It also contains a financial report of the year and quarter (i.e. balance sheets and income statements showing how much money it made or lost, revenues, profit margins, etc.).  You can also find the executive compensation in this report.  Although not a tremendously exciting read, you can certainly find a lot of useful information in here.  Before you buy any stock, I would definitely recommend reading the latest annual and quarterly reports of the company.  Quarterly reports have somewhat less information.  So, yes, do have a read of the annual report even if the fiscal year is approaching the end (i.e. the last annual report would be almost a year old).  Wikipedia gives a brief but useful description of what is contained in an annual report.  You can find True Religion's annual reports under SEC filings at Yahoo Finance.

Developments at True Religion
If you are unfamiliar with True Religion and its business, much like I was when I found this stock, you should read the Part I, Item 1, Business section.  This gives you an overview of what the company does and its business strategy.  From here, I found that all of its denim products (large majority) and 80% of its sportswear products are made in the US.  Is that important?  Well, it depends.  If you are trying to build a brand that is able to sell jeans for $200+ a pair, a "made in USA" sticker is worth a lot.  More importantly, having products made in the US means that no sweatshops are used.  As an ethical/Catholic investor, this is an important factor when considering whether you want to support a particular business or not.

I rarely look at annual/quarterly reports for financial numbers, just because Yahoo Finance or MSN Money summarizes a lot of that for you in easily readable tables.  What I do look for is business direction and expansion plans.  In the case of True Religion, I was trying to see if I can find out the latter.  Under Item 7 of Part I, the report outlines the business strategic initiatives.  I want to direct your attention to the "Growth of Consumer Direct Segment".  By the end of 2009, True Religion had 70 retail stores, of which 28 were added that same year.  So, it grew from 42 stores to 70 stores in 1 year, a 67% growth in number of stores.  In 2010, it is planning to open another 28 stores, with 1 in Toronto (where I live!).

All of this expansion sounds great, but we need to verify that they are indeed profitable expansion.  The only way to find out is to look at the company's history.  A little farther down in the report, you will see a "2009 Compared to 2008" table.  This shows the 2009 vs. 2008 numbers.  As we recall, 2009 was a painful year for the economy.  Yet, we see the net sales number and more importantly, the gross profit margins increased during that year.  In that tough economy, True Religion was able to expand successfully.  Not only did it not lose money, it made even more money!  This tells me that the company has momentum and its execution is excellent.

Digging further, we see under the "Gross Profit" section that the "Consumer Direct" segment made up almost half of all gross profit, and its gross margins were highest at 73.8%.  By the way, not many companies can claim to have gross margins as high as 73.8%.  This is a clear indicator that True Religion has a brand moat.  That is, people are willing to pay a premium for its products.  As a result, the company's plan of opening more stores will only propel the itself farther ahead.

Now, I'm just doing some real rough guesses, but I would imagine a city like Toronto and its surrounding areas could probably eventually sustain 3 to 4 True Religion retail stores.  If you live around here, these are my guesses: 1 to 2 downtown (Eaton's Centre & Yorkville), 1 West End (Sherway Gardens maybe), 1 Yorkdale.  The Greater Toronto Area has about 4 million people in population and the US and Canada together have about 340 million people.  If 4 million people can support 4 stores, 340 million could probably support 340 stores.  If I were half correct, 170 stores would be feasible.  This is still 243% more stores than there were at the end of 2009.

Going back to the "Gross Profit" section, we can see that "International" gross profits grew by 56.4% in 2009.  So, the company's expansion plan into the UK and Japan is a continuation of those efforts and I'm hopeful that they will succeed there as well.  The international market for True Religion products are quite small (only 14% of net sales are from international sales).  So, there is definitely room to grow there.

What Else is Good?
Yes, the expansion plans look fairly optimistic, but is this a green light to buy?  No!  You must look at all of the fundamentals of the company.  From what I learned in Phil Town's book, Rule #1, the Big 5s we need to look at include: a minimum of 10% ROIC (return of invested capital), and minimum 10% yearly increase in sales growth, earnings growth, book value per share growth, and free cash flow growth.  The company satisfied all of these criteria with flying colours for the past 5 years, with the exception of a blip in the earnings growth last year (it increased by 4.9% rather than > 10%).  The company also has no debt.  The P/E is currently sitting at 16.4 while analysts estimate it will grow by 31% yearly over the next 5 years (translation: the stock is undervalued big time).

So, do your homework, and if you decide to join me in being a shareholder, we'll see you when the stock hits $100!  At that point, I may consider going to Winners to pick up a pair of last season's True Religion jeans!

Whew! Finally a Break!

Wow...I had a heck of 2 weeks!  At work, I'm working on a machine that manufactures blood testing cassettes for a major healthcare company (due to non-disclosure agreements, unfortunately, I cannot name the customer; otherwise, I would recommend you to look at it for investment prospects).  The machine is close to being shipped and so, we're in crunch mode.  At the same time, my term was coming to an end, which meant my final paper was also due (last Friday).

So, I finally handed in my paper last week and at the same time, it's tapering off a little bit at work.  It's one thing to pull long hours at work, and being able to relax at home, but quite another when you work for 12 hours and then go home to work some more, and repeat it for the rest of the week.  Anyway, now that most of that is behind me, and I have the summer of for school, I'm going to try kicking it up a notch on my efforts on this blog.  My aim is to publish 2-3 posts per week.  Now that I've published this goal, I will feel accountable for it.

So, watch for my next post in the next few days...Have a good week!

Don't Forget to Give Back!

Giving

A reader recently sent me a video on how fair trade is helping Kenyans improve their standard of living.  After watching the video, it really puts things into perspective.  In the video, one of the first things that was mentioned was that that many live on $1 a day.  That translates to $30 per month.  How easy it is for us to blow $30 on a single meal!  My wife and I brought our 11 month-old daughter to Burger King tonight and even with a coupon, we spent $11 on our meals (no, we didn't feed our little Adele a Whopper...just the two of us eating)!

While I advocate direct depositing part of your paycheck into a retirement investment account as a way of saving for retirement, I also think monthly donations to your favourite church/charity is an obligation that Christians should bear.  I'm not talking about tithing (giving one-tenth of your salary to the Church); rather, it's making a financial sacrifice, however small or large, to show our Christian charity to the less fortunate.  While not all of us have the freedom to volunteer to go on missionary trips or to distribute food to the needy, the very least we can do is put our money to work.  There is really no "right" amount to give, but I would think if you were to sacrifice one nice meal per month and donate that, it'd be a good start.  One of the great things about donating to a charity is that chances are, it's tax deductible!  So, go ahead, be generous!  Not only are you preparing yourself for a nice tax refund after April, you're also storing treasures for yourself in heaven!

Misconceptions About Catholics

Another reader, Karen, sent me a blog post that she had written about the misconceptions about Catholics.  I'd bet some of you have those misconceptions yourself!  Go ahead and give it a read!

Technical Analysis: The Crowd Mentality

The Crowds Around Jesus

During Jesus' ministry, there were many instances of crowds gathering around him.  In the Gospel of Matthew, Jesus started preaching in 4:12, and not long after that, in v. 25 of the same chapter, crowds began to form around him wherever He went.  In chapter 13, the crowds were so large that he had to preach to them from a boat.  In chapter 21, as Jesus was entering into Jerusalem, the crowds laid their cloaks on the group to make a carpet for his donkey to walk on.  However, the crowds were not always on Jesus' side.  During his trial, the Jewish leaders were able to persuade the crowds to have Pontius Pilate release Barabbas, and not Jesus.  Pontius Pilate eventually succumbed to the pressure of the same crowd and condemned Jesus to be nailed to the cross.  These were the same people who had laid their cloaks on the ground a few days earlier!

What was going on?  I would attribute this to the "herd mentality" or "crowd mentality".  Sociologists tell us that people often behave the same way as their peers do.  We know all about that, don't we?  Remember when you were in highschool and your friends all dressed a certain way?  You knew you had to dress that way also in order to fit in.  A few years back, when the show "24" was really popular, a good number of my coworkers talked about it over lunch, and eventually, I got the DVDs.  While it was a good show, the reason for starting in the first place was definitely because I wanted to be able to join in the conversation with my coworkers, and not because of any objective evidence that the show was good.  (By the way, the first 5 seasons were really good!)

Crowds in the Market

It is no different in the stock market.  When others buy a particular stock and drive the price higher, you would likely feel compelled to buy as well, seeing how well the stock is doing.  When the stock is being hammered, you would also want to bail.  It's a little over-simplified, but in general, this is what happens.  Using the past price action of a stock to forecast its future price movement is called technical analysis.  Technical analysis may seem to be very scientific, using averages, standard deviations, regression, etc., but let me assure you, it is an art!  Don't be fooled!

There are a plethora of technical analysis tools available to you, from moving averages to stochastic indicators to Bollinger bands to Fibonacci retracements to MACD (Moving Average Convergence Divergence), etc.    However, in any given day, only 5 pieces of information of a stock is collected: opening price, closing price, high price of the day, low price of the day, and volume of the stock.  Most of the time, the various tools just use the same data in different ways to give seemingly different indications.  In my opinion, it's just the same information.  It's no different whether you use 1 tool or 10 tools in some convoluted combination.  This is where the KISS (keep it simple, stupid) principle really applies.

Which is the Best Tool?

I usually have something like 5 tools/indicators plotted on my stock charts, but when I reflect upon which ones I use the most, I would have to say 95% of the time, I only really look at the exponential moving average (EMA).  A little definition: a moving average is simply the average over a certain period.  So, the 50-day moving average of a stock is simply the average of the closing prices from the last 50 days.  An exponential moving average is one that simply gives more weight to the more recent data.  I like the EMA more than the simple moving average.

Above, you can the graph of S&P500.  By the way, the black and red "bars" are called candlestick chart.  I'm not going to go into candlestick charting here, but a quick google will get you started.  Learn it, it's very useful!  Sorry, where were we?  Yes, EMA!  In the chart above, you will see, in addition to the stock prices, a blue line and a red line.  The blue line is a 30-day EMA and the red line is a 250-day EMA.  The EMA lines can be considered as resistances and/or supports.  You can say that once the stock price goes pass the line, it will be more difficult for it to reverse its motion.  It's kind of like Newton's first law of motion.

With the 30-day EMA, since it is a shorter-term EMA, prices in the short term will find resistance/support.  However, it is not to be used as a long-term resistance/support.  As you can see in the chart of about 18 months, the stock price broke through the 30-day EMA multiple times.  So, I would consider the 30-day EMA a short term tool (unless if you're day trading, then perhaps you need a 30-min EMA).

I really like the 250-day EMA because I don't believe in short-term trading.  My time horizon for any given position can be a few years long.  If you look at the month of July in 2009, S&P500 broke through the 250-day EMA  Since the "strength" of the 250-day EMA is high, it is very difficult for the index to break through unless there is a fundamental shift in the market mentality.  The market is turning from a bearish view to a bullish view.  In February of 2010, the index had a correction and dipped to the 250-day EMA, but once it got close to it, it bounced right back.  This is what we call support.  So, remember, the longer term an EMA is, the stronger it acts as a resistance or a support.  So, it's big news when an index breaks a 250-day EMA!  That's why I'm currently bullish about the market.

If you are a long term investor, like me, then the EMA will get you pretty far.  There's little need for the fancy tools.  However, once you get comfortable with the EMA, it may be wise to explore a little more and see what works for you.  Having said that, EMA has worked well for me.

The one concept that you need to take away from this post is the concept of break out.  Again, I will use the analogy of Newton's first law of motion.  Essentially, Newton says, "If an object is traveling at a certain velocity, unless you exert force on it, it will travel in the same speed and direction forever!"  In the stock market, unless there is sufficient cause for a trend to reverse, it will continue in that direction.  But once you do notice a change in direction (i.e. the breaking out of a stock through an EMA or a resistance/support level), the trend may very well be over.  It doesn't always happen that way though.  The price may break through for a few days and bounce right back to where it was.  So, keep your eye on it when you suspect a break out happening.

Where Can I Get the Tools?

So where can I access these technical analysis tools, you ask?  Yahoo Finance has a pretty good interactive chart.  I also like Stockcharts.com. Either one will be sufficient.

Stockcharts.com also has a good section on chart patterns.  Give that a read when you have time.  From my experience, I like looking for patterns and has typically worked well for me.  I may write a post on that topic, but for now, give Stockcharts.com a read.

Technical analysis is an interesting topic.  Some people swear by it, following their indicators to buy and sell their stock.  Others dismiss it as a black art.  I sit somewhere in between; it's a tool for me to confirm my hypotheses.  Anyway, it is fun to read a chart and be able to find patterns in the apparent chaotic movement of the prices.

It's a little late, but I will wish you a Happy Easter (we're still in the Easter season according to the Catholic calendar, until Pentecost)!  The Lord has risen...enough said!  Alleluia!