BARE-EYED BLINDING 144.6% Hot IPO Michael Kors Holdings (KORS) Sets Up For 2013 Repeat?

Dr. Scott Brown

 

By Dr. Scott Brown

I have been watching Michael Kors (KORS) ever since it showed up on my Volume +50% Change screen.  You may not know the firm Michael Kors Holdings (KORS).

The Retail Godzilla from Hong Kong

My mom had the pleasure of visiting Hong Kong.  She reported that it is a shopper’s paradise. Of course this makes sense when you consider Hong Kong’s retail relationship with China.

The Hong Kong business environment exhibits informal rules and trust in business interactions (Redding, 1997). Indeed, serious trust built on interpersonal obligation is an important ingredient of successful horizontal ties in modern Chinese societies, including Hong Kong (Wong, 1996; Lovett, et al., 1999). In such relations, authority relies on paternalism and the rules that surround interactions are essentially Confucian (Tu, 1996). Firms also tend to be Chinese family businesses (CFBs) run by family members (Redding, 1993; Brown, 1995; HKTDC and Enright et al., 1999). CFBs derive major strengths from a paternalistic form of management that provides strong leadership and a clear sense of purpose. The socially constructed nature of the market also underpins the distinctive feature of Chinese business networks, which are made up of CFBs (Whitley, 1992; Redding, 1996; Pyatt, 1999).”

 

See Trimarchi, Michael, (2012) “Relationships compatibility in interactions between Mainland Chinese, Hong Kong Chinese and Western Actors,” Working Paper

The Chinese business practices Hong Kong based Michael Kors (KORS) utilizes offers the firm a durable advantage over other apparel stocks in this industry.  Michael Kors Holdings (KORS) controls Chinese mainland supply relationships through Hong Kong. The firm simultaneously dips its fingers directly into household wallets and purses through 2,000+ retail outlets in first world major markets of Japan, Europe, and the United States.

Industry Leaders: Apparel
Rank Symbol Company
#1 KORS MICHAEL KORS HLDGS LTD
#2 GIII G III APPAREL GROUP INC
#3 UA UNDER ARMOUR INC CL A
#4 VFC V F CORP
#5 CRI CARTERS INC
Source Investors.com

Born From Project Runway

Michael Kors (KORS) is a very well received IPO within the last 12 months.  It’s been like a bucking bronco ever since.

The Hong Kong-based company, named after fashion designer Michael Kors — a judge on TV show ‘Project Runway’ — is going public at a time when U.S. investors are being highly selective about their IPO investments. ‘That he is a well-known designer is a very positive thing and there is the thinking that the luxury end of the market, which he represents to a certain extent, is making a comeback as markets stabilize,’ said David Menlow, president of IPOfinancial.com.”

See full article HERE.

The Fundamental Numbers

Doc Brown’s Trading University Trade of The Week
Stock Michael Kors Holdings
Symbol KORS
Type (Contrarian / Momentum) Momentum
Sector Apparel
Exchange NYSE
IPO Date 12/12/2011
IPO Price $25.35
IPO Offering Price $20.00
IPO Shares Outstanding (Millions) 47.2
Sales Growth (3-Year) 58.0%
Earnings Growth (3-Year) 134.0%
Earnings Acceleration (Qtr. To Qtr.) 162.0%
Annual Return on Equity (ROE) 56.2%
Date 10/3/2012 3/14/2012
Shares outstanding (Millions) 193.20 191
Composite Rating 98 98
EPS Rating 98 98
RS Rating 96 99
Group RS Rating B A+
SMR Rating A B
Acc/Dis Rating B- A-
Source Investors.com.

 The fundamental numbers on this stock are absolutely stunning.  Annual return growth and acceleration on equity, earnings and sales are all double digits.  The IPO closed above its offering price on first trading day.  Share prices have been making new annual highs. There are just three imperfections to this shining example of a momentum stock.

1. The shares outstanding figure is high.

Companies that have between 5-30 million shares outstanding catch my eye in particular.  I am very comfortable with stocks that have up to 50 million shares outstanding. Michael Kors (KORS) has 193.2 million shares outstanding.  Worse they are issuing more.

2. The Apparel Group Relative Strength rating (Group RS) has been downgraded…

from a very healthy A+ last March 2012 to a lukewarm-esque B rating.  Here’s how you can understand this.  Imagine averaging all of the price movements of the stocks in the apparel industry. On an aggregate industry price graph you would see that apparel has lost ground to other groups in the global economy.  This harkens to a simple but powerful strategy of buying stocks that are leaders in industries (groups) with A or A+ Group RS Ratings. This company would be rejected based on that filter due to the moderate aggregate price weakness of the apparel industry group.

3.  The ACC/DIS Rating has been downgraded…

from an A- to a B-. ACC/DIS ratings track the relative degree of institutional buying (accumulation) and selling (distribution) over the last 13 weeks. The ACC/DIS rating starts with data that is compiled by the SEC through the Form 13F

An institutional investment manager that uses the U.S. mail (or other means or instrumentality of interstate commerce) in the course of its business, and exercises investment discretion over $100 million or more in Section 13(f) securities (explained below) must report its holdings on Form 13F with the Securities and Exchange Commission (SEC).

You can measure changes in the amounts of institutional money manager buying and selling via 13F electronic data compiled by the SEC’s EDGAR system.  But the user un-friendly nature of the data would take you forever to do so. Investors.com compiles this information and reports it as nominal data in a letter rating measure they call the “ACC/DIS Rating.” An A+ represents the strongest buying to accumulate a mid or short-term position by institutional money managers.  An E- represents the most aggressive selling for profit taking, risk management, or asset allocation purposes. Remember that these are relatively small cap stocks as compared to blue-chips.  Smaller cap momentum stocks such as this are generally held for shorter terms by aggressive mutual and hedge funds. Institutional money managers represent mutual funds, hedge funds, pension funds, and insurance companies.  It is easiest to think of the ACC/DIS rating as an index of institutional interest in the stock.  High levels of ACC/DIS represent recent interest in the stock and vice versa reflecting disinterest. It is particularly important to track this ACC/DIS rating over time to understand how institutional volume fluctuates both in size and in direction.  The big question I had this time last year was directional…

How Does The ACC/DIS Rating React To Market Down Turns?

If you could time travel back to February of last year you would have noticed that companies with very strong momentum fundamentals like Michael Kors (KORS) had ACC/DIS ratings rarely below A-.  Fast forward to September when the VIX skyrocketed over 37 as stock indexes fell into the dumpster. The weekly chart of the E-mini S&P 500 futures contract shows that the stock market was bearish from July 3rd to October 9th.  The market was bullish from October 10th to March 25th. I estimated measures of central tendency and dispersion for the ACC/DIS rating over that time.  These are calculated from the initial ACC/DIS values of recommendations I tracked over the stock market Bear Phase from Jul 3 to Oct 9 2011 and Bull Phase from Oct 10 2011 to Mar 25 2012. I assigned a number from 1 to 15 to each ACC/DIS letter rating.  I then calculated the mean, median, and standard deviation of ACC/DIS.  Finally I mapped each result back to a corresponding letter grade.  Here are the results…

ACC/DIS Measures of Central Tendency and Dispersion
Bear Phase Bull Phase
Observations 67 67
Average ACC/DIS C- B-
Median ACC/DIS C- B
Standard Deviation ACC/DIS* 3.66 2.68
*This measures the volatility of accumulation and distribution. 

 ACC/DIS values drop a full letter grade in a bear market!

Institutional change in position size is more volatile during downturns.  The gist of this table is that you should expect ACC/DIS values to drop in bear markets and rise in bull markets. This helps explain the persistent Wall Street lore that, “share prices go down up by the stairs and down by the elevator!”    ROFL! 🙂

The Technical Picture

Michael Kors Holdings (KORS) shows technical strength as an ascending share price trend starting at $23.45 last December to $57.35 now in the beginning of October.  That is a holding period return of [($57.35 – $23.45) ÷ $23.45] x 100 = 1.445 x 100 = 144.5%.  

Click photo in slideshow to enlarge…

KORS-Michael Kors Holdings Ltd.-WEEKLY

KORS-Michael Kors Holdings Ltd.-WEEKLY

KORS-Michael Kors Holdings Ltd.-DAILY

KORS-Michael Kors Holdings Ltd.-DAILY

ESZ2 - S&&P 500 Stock, mini 2012Z - Dec. - Weekly

ESZ2 - S&P 500 Stock, mini 2012Z - Dec. - Weekly

ESZ2 - S&&P 500 Stock, mini 2012Z - Dec. - Daily

ESZ2 - S&P 500 Stock, mini 2012Z - Dec. - Daily

Apparel

Apparel By Michael Kors Holdings (KORS)

KORS-Michael Kors Holdings Ltd.-WEEKLY thumbnail
KORS-Michael Kors Holdings Ltd.-DAILY thumbnail
ESZ2 - S&&P 500 Stock, mini 2012Z - Dec. - Weekly thumbnail
ESZ2 - S&&P 500 Stock, mini 2012Z - Dec. - Daily thumbnail
Apparel thumbnail

The Opportunity

Take a look at the daily chart in the slideshow for this post. The top of the most recent accumulation base is $57.49.  Michael Kors Holdings (KORS) moves into annual new high ground above this price level. Such an upward break re-confirms momentum. Here is how I spotted KORS on my Volume 50%+ screen. Notice that Michael Kors (KORS) went through more than a month of low volume from mid June through the second week of August.  Volume soared well above the point at which the prior low volume would have been twice exceeded the prior four week average on August 14. The share price simultaneously gapped over upper resistance of the consolidation that formed during the low volume weeks before.  This is a bullish indication.  See daily chart in slideshow. 

The Danger

Momentum is violated if the share price falls below base support at $50.80. Be particularly cautious in your stock trading when the slope of the trend line steepens more than 45 degrees.  When this happens expect a pull-back (reaction) to a shallower trend-line of less than 45 degrees or less on a daily chart. Just eyeball this. Don’t get out a protractor.  Don’t over-think your way into paralysis by analysis. Use your “lizard” brain as real estate guru Ron LeGrand says.   Over time your lizard brain will immediately see what “too” steep of an uptrend (downtrend) looks like. This has happened once with Michael Kors Holdings (KORS).  Look at the very fast rise from January through March of this year on the daily chart in the slideshow.  Notice how the weakness from March through August simply adjusted the uptrend to a reasonably shallow (rather than steep) slope. See the weekly chart in the slideshow of this post.

The Den of Thieves Theory of Market Macro-Structure

You might have noticed that I call consolidation bases something else in the slideshow.  I call them accumulation bases.

This comes from a loosely organized series of seemingly unrelated and random thoughts that thread through biographical studies of great traders from Jesse Livermore to Ted Warren to Stanley Kroll. Sideways movements last for a month or more following institutional profit taking.

The well trained “plugged-in” Wall Street big dogs sell out to undisciplined, uninformed “grasping-in-the-dark” Main Street Joe Plumber investors.  

Institutional money managers minimally support the market.  In other words they buy when the market falls to a certain level but do not continue buying as the market rises. This induces a technical formation known as a narrow sideways channel.  This wears the impatient public out. The Nervous Nelly sells the gradually grinding “dead money” stock like a chubby pampered Cub Scout drops a rubber rattle snake found upon wilderness repose tucked into his sleeping bag by some prankster.

My colleague Alex Green finds this mentality of the novice investor rather boring — as do I. 

He states in an Investment U email on September 25th, “A client who sits on a stock – or even a stock fund – for six months and doesn’t see a spark will remind you with every conversation that he or she is sitting on “dead money.” Wall Street’s Den of Thieves gradually drive the public out of the stock.  Shares transfer from upper and mid-range households of the “We Are the 99” to the 1% who occupy the financial predation micro-clime of their blue blooded ecology.

Once the 1% has accumulated enough shares they signal colluding pros to move the price upward. Institutional money managers enter with strong buying pressure.  Prices are “managed” above the resistance of the accumulation base.  After the “little suckers” are driven out. The 1% pushes the “We Are the 99!” out of the most profitable positions.    “Weaker hands” willingly pass shares to “stronger hands.” So the conspiracy theory goes.

In this view an accumulation base is just one Den of Thieves technical formation.  I have other Den of Thieves technical formations I’ll show you another time. Ripping off the “dead money” public may be a natural force of financial Darwinism.  Forest fires “prune” old stands of dead timber. Uncle Paul Samuelson thought this way. Institutional herding may be an artifact of money managers riding the back of the pack.  Here is an erudite discussion of the topic. 

Read the article Should We Expect Superior Managers to Be Stars? (Dis)Incentive Effects of Fund Flows in Money. Professor Sotes-Paladino holds a Ph.D. in finance from the University of Southern California (USC).

He is a senior lecturer (associate professor) of finance at The University of Melbourne.  This is the #1 university and business school in Australia. It’s fun to contemplate the Den of Thieves theory of market macro-structure. 

And I do believe that there is some truth to the theory. 

I just don’t know how much. The Den Theory is fine stuff for conversations over 18 year aged single malt Scotch while smoking Cuban cigars.  My balcony overlooks a spectacular Caribbean paradise. That is as far as I have known this theory tested. Hopefully you’ll survive the manipulations of the 1% … meanwhile.  I’ll watch from afar.  ROFL! 🙂

Money Management

We are currently in a bull stock market.  My colleague Dr. Mark Skousen campaigns the importance of earnings strength.  That means focusing your portfolio on stocks showing strong double digit growth and acceleration of earnings and sales. Such stocks are more likely to offer the most bang for your buck should this bull market strengthen through 2013.  But what if the general stock market weakens as it did last fall? Prudent money management entails stabilizing your stock returns by placing at least 70% of holdings in a core passive portfolio.  The best (and easiest) core passive is the Gone Fishing Porfolio by Alex Green. JUST MAKE SURE YOU REBALANCE EVERY YEAR!

Get book on Amazon.com here…

 

Restrict the remaining 30% of the portfolio to single stock (or stock option) strategies to no more than 20% per position.  This ensures that no more than (0.30 x 0.20) x 100 = 0.06 x 100 = 6% of your annual retirement portfolio contribution is at risk in any single stock.

Stops and Mental Stops

As I write this post the market is trading at $52.75.  Entry at market with a mechanical stop-loss at $50.80 is a [($52.75 – $50.80) ÷ $52.75] x 100 = [$1.95 ÷ $52.75] x 100 = 0.037 x 100 = 3.7% initial risk (1R). The accumulation base support level of $50.80 is a great level for a mental stop. Remember that option traders have to use mental stops.  The option market is illiquid.  Mechanical stop orders face too much slippage. Slippage is mean zero according to

Brown, S., Powers, E. and Timothy W. Koch, (2009), “Slippage and the Choice of Market Versus Limit Orders,” Journal of Financial Research.

The central tendency of slippage is zero but it simply inserts too much uncertainty in terms of maximum drawdown on a specific stock option trade. The market can gap over a stop limit in fast moving markets and just as quickly recover on any given day. An at-the-money 50 February call with 136 days to expiration has a theoretical price of $9.40 and a delta of 67.5%.  A stock option controls 100 shares. The option costs $940. I normally invest in stock options that are deep in the money with deltas in excess of 80%.  67.5% is 12.3% low for delta but there is a cost tradeoff.  A professional stock option trader like Ron Ianieri would likely recommend the higher delta of 80%. Don’t forget to check the implied volatility of the stock’s options HERE. You want to see the (gold) implied volatility line in the lower half of an annual volatility chart when you buy as stock option.  You want it in the upper half when you sell a stock option. An in the money 48 February call has a theoretical price of $8.25 and a delta of 63.0%.   The option costs $825 of your hard earned savings. The deeper in the money call costs ($940 – $825) = $115 more.  The 4.5% increase in delta does not justify the additional cost in my opinion.  Again there is some trade off on long calls between delta and cost. Just try to keep delta as high as possible.   An option calculator will help you see the tradeoffs in quantitative terms.  If I run across a really good option calculator I’ll show you how to do this in another post. Again a mental stop at $50.80 is $1.95 below the market price.  A 63% delta (holding this variable constant) implies a $1.95 x 0.63 = $1.23 maximal loss if a trader can act on his or her mental stop fast enough. A newsletter recommendation of this stock proffered a $43 mechanical initial stop loss on a stock position.  This is a reasonable stop for a stock position but not for a stock option.  Let me explain… The resistance of the prior consolidation is at $45.36. There’s an enourmous difference in risk for these three initial stop levels for the option trader as compared to the stock investor.

Stop Level Initial Risk (1R) Stock Investor Risk Stock Option Trader Risk*
 $    50.80  $       1.95 3.7% 23%
 $    45.36  $       7.39 14.0% 89%
 $    43.00  $       9.75 18.5% 117%
* Holding delta constant.

A 3.7% initial risk for the stock investor inflates to 23% for the stock option trader.

-Dr. Scott Brown

PS. If you don’t play you can’t win.  If you lose everything you can’t play.  🙂

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