A Core Holding for Any Growth Portfolio

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If you are a growth investor, run, don’t walk, to add Michael Kors (NYSE: KORS) to your personalized Watchlist right now. Okay, now that you can keep up with this amazing story, let me give you a few reasons why I believe this company should be a core holding in any growth portfolio.

Luxury = Economies Don’t Matter

In most industries, the strength or weakness of the economy can either be a help or a hindrance. The best example of an industry that does not directly correlate to the economy is high-end retail. Though it sounds like a generalization, the facts are what they are, people who make a lot of money don’t care as much about the economy. Let me give you a quick example.

If you make $30,000 a year, your main concerns are basic necessities, food, water, clothing and housing. When you make $3 million a year, your basic necessities are a foregone conclusion, and you can look for ways to spend your money. One of the main ways that well off consumers choose to spend their disposable income is on clothing, accessories, and anything that establishes their lifestyle.

This isn’t to say that if you are well off that you don’t care, it’s just to prove the point that high-end retailers benefit from the spending habits of their clientele. Michael Kors certainly isn’t alone in this industry. Companies from Fossil (NASDAQ: FOSL) that license Kors to direct competitors like Ralph Lauren (NYSE: RL), and PVH (NYSE: PVH) all want a part of the action.

What Makes Kors Different?

One of the main differences between Kors and their competitors is size. Ralph Lauren and PVH each sold over $6 billion in goods last year. By comparison, Fossil sold about $2.8 billion, while Kors sold about $2.1 billion. Investors can benefit from this size differential because Kors simply has more room to grow.

To give you an idea of the difference between a company with $6 billion in revenue like Ralph Lauren, and one with $2 billion like Kors, consider the following. Over the next few years, analysts expect Ralph Lauren to grow earnings by about 11%, they expect Kors to grow by nearly 29%. With PVH expected to grow by 12%, and the smaller Fossil expected to grow EPS by 15%, you can see this relationship hold true.

What is equally amazing is the size of Kors’ opportunity going forward. The company grew sales in the current quarter by 57%, and same-store sales were up over 36%. With North America representing over 86% of the company’s sales, you can see this concept has room to grow.

What is equally impressive is Kors’ margins in particular because they are growing so fast. Many times, a company will sacrifice short-term margins for growth, but with Kors, investors get both huge growth and great margins. In the current quarter, Kors managed a gross margin of 59.7%. If we compare this to their peers, only Ralph Lauren came close with a 59.29% margin. PVH and Fossil didn’t do badly either, with gross margins of 53.82% and 55.59%, but of course neither of these companies is growing as fast as Kors.

One thing I’ve learned is, there are a lot of numbers that can be manipulated, but cash on the balance sheet is pretty hard to fake. In the last year, Kors’ net cash and investments has jumped from $106 million to $472 million. The company’s 344% increase in cash might be one of the most impressive numbers of all. While Ralph Lauren has more total cash at over $1 billion, Fossil’s cash pile of $90 million looks small compared to Kors. When you consider that PVH has a debt-to-equity ratio of 0.68, you can see the wide variation in this industry.

The Best Reason Of All

As you can see, there are many things that make Kors different from their peers, but the best reason to buy the stock might be the relatively cheap valuation. While Kors does sell for a forward Price/Earmings (P/E) multiple of about 24, based on their expected growth rate, this is a bargain price.

If we look at Kors’ peers, they each sell for a premium to their expected growth rate. Ralph Lauren carries the biggest premium, with an expected growth rate of about 11% being offset by a forward P/E of nearly 20. PVH comes in second, showing a 12% expected growth rate, but a P/E of nearly 16. Ironically Fossil is growing faster than both of these companies, yet sells for a slight premium with a P/E of about 17, and an expected growth rate of about 15%.

When you realize that Kors’ competitors sell for premiums of between 12% and 80%, it’s almost unbelievable that Kors sells for a discount of 15.7% to its growth rate. Given the company’s huge potential worldwide, faster growth rate, growing cash pile, and better margins, something is off. Growth investors should take this opportunity to add KORS to their portfolio, before the market wakes up and realizes what’s going on.

Chad Henage has no position in any stocks mentioned. The Motley Fool recommends Fossil. The Motley Fool owns shares of Fossil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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