Shares of Garmin (NASDAQ:GRMN) dropped sharply in early May after the consumer technology company failed to raise its full-year 2019 guide after topping first quarter expectations. The implication? The next three quarters will actually be below consensus. Investors weren’t too happy. Garmin stock dropped 7% in response. The stock now trades below $80 for the first time since mid-February.
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Some contrarians may look at the drop below $80 as an opportunity to buy the dip in what has been a red-hot stock. But, the appropriate way to look at GRMN is that it was simply overvalued above $80. Thus, this drop below $80 is a much-needed correction, and not an opportunity to buy just yet.
Zooming out, this is a consumer technology company that has decent, but not great, go-forward growth prospects, on healthy, but not surging, margins. Yet, Garmin trades at a valuation that implies both great growth and surging margins. This disconnect won’t last forever. Indeed, right now, the disconnect is in the process of fixing itself.
The “fix” could drag Garmin stock all the way down to and potentially even below $70. Thus, until this stock gets closer to $70 than $80, investors should avoid buying the dip.
Garmin’s Growth Narrative Is Average
In the big picture, Garmin’s growth narrative is average.
This company markets and sells technology hardware products across a variety of industries, mostly focused on wearables, smartwatches, cameras, and other GPS-enabled devices. Growth in this category is good and healthy. Over the past several quarters, Garmin has reported consistent mid to high single digit revenue growth on growing demand for new products across its Aviation, Marine, Fitness, and Outdoor segments.
But, mid to high single digit revenue growth isn’t anything to write home about, especially considering that the growth trajectory is slowing.
In 2018, revenues rose 7%. This year, revenues are expected to rise just ~4.5%, and analysts peg revenue growth at ~4% the following year. Revenue growth across the whole market is expected to average around 5-6% over the next two years. Thus, Garmin’s revenue growth narrative is actually fairly average, and arguably below-average.
Meanwhile, gross and operating margins have been on a solid upward trajectory for the past several years. But, that trajectory is hitting some turbulence in 2019.
Specifically, both gross and operating margins fell back in the first quarter of 2019 amid pricing and mix pressures in the company’s biggest segment, Fitness. These pressures are expected to persist. For the full year, operating margins are expected to drop.
Consequently, the guide calls for flat EPS growth in 2019. Analysts see just ~6% EPS growth in 2020. EPS growth across the whole market is expected to be around 3% in 2019, and 11% in 2020. Yet again, we see that Garmin’s profit growth narrative is actually fairly average, and arguably below-average.
Overall, Garmin’s growth narrative is largely below-average to average. The problem with Garmin stock is that the valuation doesn’t reflect this reality.
The Valuation Implies Above-Average
The valuation underlying GRMN implies that this stock has an above-average growth profile, which it doesn’t.
Even after the post-earnings sell-off, Garmin stock still trades at 21-times forward earnings. That’s a big multiple. The growth-average forward price-to-earnings multiple in the stock market is just above 21, while the market average multiple is 17. Thus, GRMN stock is trading at a sizable premium to the market and at a growth-type valuation.
But this isn’t a growth stock. Growth stocks are double-digit revenue growers with healthy margin drivers, and ultimately something north of 15% annualized profit growth potential. Garmin is a mid single digit revenue grower with margin pressures, and ultimately something like 5-6% profit growth potential. That’s below market average.
As such, this correction in GRMN stock should persist until the valuation starts to make sense. When does that happen? Around the market average multiple of 17. Applying that multiple to what I think could be $4 in EPS next year, that equates to a 2019 price target for Garmin stock of $68.
Bottom Line on Garmin Stock
Garmin stock simply got way head of itself in early 2019. Now, the stock is reasonably pulling back to much more fundamentally supported levels. This correction should persist for the foreseeable future. I wouldn’t be a buyer until the stock drops closer to and potentially even below $70.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
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