Should You Liquidate Lumber Liquidators?
Lumber Liquidators Holdings Inc. (LL) is a leading retailer of hardwood flooring with an excellent operating history. The company has no debt, and a historical growth rate of 20% per annum. Moreover, they are expected to have an exceptional year in fiscal 2012 as earnings accelerate off of a flat base in 2011. However, we believe that short-term optimism has driven the stock to an unjustified high valuation. Business is good, and should continue to be good, but nowhere near as good as today’s valuation indicates.
Growth stocks are defined as companies with high rates of change of earnings growth of 15% to 20% or better. Growth stocks offer the potential for share prices to rise in lockstep with their profit growth in the long run. Therefore, the PEG ratio formula (price equals growth rate) tends to be the most appropriate formula used to value growth stocks. However, due to the exponential nature of compounding large numbers, PEG ratio forecasts are capped at 40%.
Because of the higher valuation typically awarded to fast growth, growth stocks offer the potential for greater capital appreciation. On the other hand, they also offer higher risk. First of all, they tend to command much higher-than-average PE ratios, and second, achieving very high levels of growth is very difficult to sustain. Consequently, forecasting future earnings growth is more important with high growth stocks than any other class of stock. Also, the average growth stock typically plows all of its profits back into the company to fund its future growth, instead of paying dividends.
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