With Fossil (FOSL) Stock Look to Future Earnings

Fossil Group Inc (NASDAQ: FOSL)

As the bell rang to open the markets this morning, Fossil took an epic beating by opening at a share price over 30% lower than the previous day, going from $40 a share the previous day to opening at $26.50. That is an astonishing one day collapse in any company’s stock. So what’s going on?

Fossil released its Q1 results yesterday and it wasn’t pretty. The company faces major headwinds with declining sales in every region they operate. Watch sales were down 10%. Jewelry sales were down 13%. Gross margin declined by 2.5%, 1.6% of which was due to a stronger US dollar and 0.9% due to more discounted sales. Operating margins compressed 5.5% to 2.2% for the quarter and earnings per share fell from $0.75 in Q1 2015 to $0.12 Q1 2016.

Fossil’s management is guiding for sales growth of -5% to -1.5% in 2016. This means that earnings per share for the year is guided at between $1.80 to $2.80. This is drastically lower than earnings per share in 2014 which was $7.10 and 2015 which was $4.51.

If you bring up Fossil on a stock screener, you will immediately see a price-to-earnings ratio of around 6. You might think this could be a good deal, as the stock has traded in a band of 13 to 15 P/E multiple in 2014 to 2015. This might lead you to think that with a little bit of P/E expansion back-up to its historic P/E range, you could make a tidy little profit at today’s pummeled stock price.

I’d be cautious. That P/E ratio of around 6 that you see pop up is based on 2015 earnings per share of $4.51. If we take the middle of the range that Fossil’s management guided for 2016, we come to $2.30 expected EPS for 2016. Based on this future estimated earnings per share figure, at around $29 per share, the P/E ratio all of a sudden is 12.6. If you are more pessimistic, the forward P/E ratio is even higher. All of a sudden, Fossil doesn’t appear to be as great of a bargain: it’s trading around its historic P/E range of the last couple of years but with severely declining sales and margin compression.

You should be careful when using future estimated earnings because they are just estimates. However, in a situation such as Fossil’s, it forces you think a little bit harder than what a stock screener will initially bring up. It’s easy to get trapped into thinking that Fossil could be a bargain when in reality, there is a reason that the stock dropped almost 30% in share price: declining sales and much lower expected earnings per share in 2016 has led the market to readjust the share price to reflect those lower expected profits.

The situation has similarities to the issues facing Gap. Don’t get fooled by historic revenue and profit numbers that may obfuscate the reality of the current economic engine of the business. Fossil is facing some real challenging issues so you better conduct your due diligence before becoming an owner of the company at these depressed levels.

Disclosure: This author has no positions in any stocks mentioned and does not plan to open any positions in any stocks mentioned for at least 72 hours after publication of this article.