Ralph Lauren's Problems Are Reflected In Its Price

On Monday I bought Ralph Lauren (NYSE:RL).

Before getting into the numbers, I use a Valuation Model that creates a 'Valuation envelope' for each stock I follow. That 'envelope' is something akin to Bollinger Bands except its computation doesn't involve price movement but rather fundamental elements. It is anchored on the smoothed 10-year earnings growth of the company and the envelope's 'width' (its boundaries) is a function of the company's financial strength, its historic absolute and relative P/Es and the stock's beta.

The lower boundary of that 'envelope' (plus or minus 10%) is the Buy zone for the stock. The upper boundary (plus or minus 5%) is the Sell zone. When a stock enters that Sell zone, my discipline is to Sell Half of the stock position. That forces me to take money off the table and build my portfolio's cash position as a source of funds when stocks mean revert. But it maintains a position in the company as long as the fundamentals don't change.

There is one final component to this Buy/Sell discipline and that is a Stop Loss Price, which is set 15% below the lower boundary of the Buy zone. This recognizes that I can be wrong and prevents me from taking big losses. However, this Stop Loss does NOT follow the price of the stock up. Once I am in a stock and have made money, I want to allow it normal volatility. In other words, I am not trying to create a trading strategy.

Now to Ralph Lauren. Its stock has been trashed over the last two years, declining from $186/share to its current price of $71.

Chart from Investools

Of course, there were plenty of good reasons for this shellacking:

(1) its international expansion has led to significant currency translation problems,

(2) the general malaise in consumer spending, intensified by the trend toward athleisure apparel and fears of the disruptive force of Amazon (AMZN) on the retail industry,

(3) the recent departure of the company's well-respected CEO, likely a result of disagreement with Mr. Lauren.

This has led to a pretty grim financial performance over the past 4 years with earnings falling about 35%, its return on equity declining by 50%, its margins decreasing roughly 30% and a slowdown in the growth rate of its dividends.

However, Ralph Lauren has a strong portfolio of products, which are recognized worldwide. More important, management has responded to its current problems by closing underperforming stores, reducing promotions, streamlining its organizational structure and cutting shop keeping units (SKUs), focusing on stronger selling items. (for more elaboration, read the latest 10-K dated 5/18/17)

True, none of this is going to stop the ongoing transformation in retail, so a return to Ralph Lauren's former earnings and dividend growth rate is not in the offing short term. However, long term, the company is not faced with the same problems as a Macy's (M) because it is not a retail intermediary and therefore, doesn't have to be dependent having a physical presence to sell its products. It can be done online via its own website or on Amazon. However, finding the right balance between a store front and an online offering could extend the timing of a recovery in growth.

I believe that all the uncertainty is reflected in Ralph Lauren's stock price. Below is a summary of some valuations metrics I include in my analysis. (Data from Zacks and Value Line).

On Monday, I bought Ralph Lauren stock at $71 and change.