This Hated Stock Could Skyrocket your Portfolio

By Kyle Farrah - July 24, 2012 | Tickers: AAPL, SKUL, SODA, SNE | 0 Comments

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There is a lot of skepticism surrounding the world of IPO’s, and for good reason. IPO’s are generally overpriced and bad values for investors. Occasionally however a stock will be so hated, so despised that it goes down into a territory where it becomes severely undervalued. Such is the case of the high-end headphone and earbud company Skullcandy (NASDAQ: SKUL).

Skullcandy sells high priced headphones that range from anywhere between $20 and $300. They provide color, and a unique brand to an otherwise boring product. This unique product offering has allowed the company to experience rapid growth. In the past six years the company has seen a compound annual growth rate (CAGR) of 91% from $9.1 million in revenues in 2006 to $232.5 million in 2011. However, in spite of the massive success the company has seen, there still remains a cloud of negativity surrounding the stock. Shorts have piled into the stock and shares of Skullcandy are trading at $14 per share, down 30% from their late July, 2011 IPO price of $20. There are currently 11.56 million shares short, or 71.5% of the float, making the company one of the most heavily shorted stocks on the NASDAQ. The shorts believe that Skullcandy’s competitive advantage is not maintainable, and that the company will be forced to slash prices to compete with the numerous other players in the industry.

Despite the low barrier to entry that headphone sets have, Skullcandy does have one advantage that differentiates it from its competitors.

Skullcandy’s Brand

Skullcandy has managed to transform something that was once sold like a commodity into a product that is able to demand a premium from the market. By adding bright colors, creative logos, and celebrity flare into their products, Skullcandy was able to differentiate their products and make them special.

In the same way that Apple (NASDAQ: AAPL) was able to differentiate their computers, phones, and music players by making them better, brighter and more lovable, Skullcandy made their music player accessories brighter, more colorful and fun. In a word Skullcandy was able to make their products “cool,” and this coolness has not gone unnoticed by consumers.

Today Skullcandy has received over 1.7 million likes on Facebook, 52,000 Twitter followers, and their iPhone app has been downloaded more than 800,000 times. People love the Skullcandy product line, and are willing to pay up for their products. This gives the company an advantage that others will have a hard time imitating.

It is hard to imagine Sony (NYSE: SNE), the largest headphone manufacturer in the World, for example coming out with anything colorful, fun or lovable. All of their products tend to be black, boring and dull. They compete at the low end of the spectrum. While it is likely that they will be able to keep most of their current customers for headphones it is unlikely that they will be able to compete at the high end against the Skullcandy brand. The same is true for all of Skullcandy’s other competitors. Almost all the major headphone manufacturers compete at the low end, and breaking into the luxury earbud market would be extremely difficult for most of them.

Growth

Skullcandy’s growth over the last several years has been incredible. Since 2006 Skullcandy has managed to grow its top line at a compound annual growth rate (CAGR) of 91%. Its five year weighted diluted EPS has grown by an average of 23% per year, and analysts estimate the company’s five year growth rate to be 19.38% per year. Given that the company has significantly outperformed expectations in each of the last four quarters it is likely that their growth will be even higher. Additionally the company has already announced that they are estimating that they will earn between $1.10 and $1.20 per diluted share in 2012. Earnings of $1.10 will be a 39.24% increase over last year’s earnings. This growth rate is incredible and should help the company to move higher.

Valuation

Using $1.10 as the EPS for 2012, a growth rate of 19.38% after that, and a PEG ratio of 1.00 the stock should be valued at $21.31 per share. If we lower the growth rate to 15% we are left with $16.50 per share. If we use the higher end of the estimate and assume an EPS of $1.20 for 2012 we are left with $23.25, and $18 per share. So the stock should be valued at between $16.50 and $23.25 a share, in my opinion. This gives investors the opportunity to see a return of between 17.85% and 66%.

Shorts

Shares of Skullcandy have been shorted heavily since its IPO last year. Currently there are 11.56 million shares short, which is 71.5% of the float, and 42% of the shares outstanding. As the market begins to realize the value of Skullcandy’s shares the price should go up, and shorts will be forced to cover. This should create a massive short-squeeze and shares will be forced to sky rocket higher.

An example of this can be seen in SodaStream International (NASDAQ: SODA). After being shorted down to as low as $30 a share, SodaStream’s stock rose to a high of $42 on only a couple of minor news stories. The huge short interest in SodaStream forced sellers to buy back their stock to avoid taking bigger losses in the future. With a short interest that is even higher than SodaStream’s was, and a growth rate that is very similar, Skullcandy should see a similar situation occur to its stock.

Conclusion

Skullcandy looks like a tremendous buying opportunity at today’s prices. I expect shares to continue to surge higher as investors realize the potential of the company and shorts are forced to cover their positions.

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