Tuning Out Skullcandy

 | Mar 11, 2014 | 2:30 PM EDT
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Stockholders who have stuck with headphone manufacturer Skullcandy (SKUL) over the last couple of years are finally feeling vindicated. On Friday, SKUL reported fourth-quarter earnings that handily beat expectations. Earnings of $0.13 per share impressed a market that was looking for a $0.09 or $0.10 result and the stock soared, touching $11.40 Monday, an increase of 53.4% over Friday's pre-earnings close. That initial pop didn't last too long and SKUL closed Monday at a more restrained $9.23 but it has gained again, trading around $10.30 Tuesday afternoon. This looks like a great turnaround story, but if you are one of those stockholders feeling vindicated, I have some advice: Sell while the going's good.

Earnings beat expectations, sure, but revenues were down 28.4% compared to the fourth quarter 2012. The day after those numbers were released a year ago, SKUL closed at $5.38.

Skullcandy (SKUL)
Source: VectorVest

I understand that markets are forward-discounting mechanisms, but seriously, 28.4% less revenue and double the valuation? It's amazing what a reaction of "It could have been worse" can produce. Relief rallies are often short-lived and this sure looks like one. The fact is that SKUL is still in decline -- declining slower than in most of 2013, sure, but still losing revenue compared to even the disaster that was last year.

When the stock was first offered in 2011, SKUL some painted the company as a major disruptor in the consumer electronics field. Looking back, it seems obvious that simply making an existing product in bright colors had somewhat limited upside. I have a deep-seated fear of trendy stocks, or rather, companies that make trendy things, and it seems that that is what SKUL is. Some, like Apple (AAPL), build a huge line off a trendy product (for example, the iPod), but the majority ride the initial wave of popularity and then fade. I'm sure Skullcandy can survive by reinventing the product a few times and diversifying somewhat, but that is the limit of my enthusiasm.

Using analysts' estimates from before Friday's earnings release, current pricing gives SKUL a forward price-to-earnings ratio of around 90. Those estimates will be revised upwards, no doubt, but, if you accept the basic assumption that SKUL is simply in a slower decline than first thought, that looks a little rich, to say the least.

I have a dealing-room background, so I was taught early that stubbornness has no place when it comes to positions: If a position is wrong, it's wrong. That's fine in a trading context, but for longer-term investors, an itchy trigger finger can lead to taking too many losses, so running even a bad position for a while is forgivable. But you should still recognize when you are being given a chance for a cheap cut. SKUL holders are being shown that opportunity now, and they would be foolish not to take advantage of it.

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