More than One Possible Setup

In the book One Good Trade by Mike Bellafiore there are several sections on expanding  your arsenal of trading setups. Read the book to find these extremely good examples.

up market[ support plays/pull backs ]
range market[ momentum ]
down market[ resistance, bounces ]

If you were to stay in a trade longer than a day would the setups change? It made me start thinking if there were not more plays for all the different trading styles. Each discipline seems to have several of its own unique time and setup plays....

Predefined Scans
The easiest examples are found in the charts, candlesticks, points & figures or technical analysis fields.

www.stockcharts.com has many of these captured with predefined scans. I use the search feature to find specific scans that other traders might be using on my stocks each day. For example, on Friday, Skechers (SKX)  search came up with

Results for SKX
Moved Above Upper Bollinger Band
New CCI Buy Signals
Elder Bar Turned Green

This Monday morning has been a volatile market start so the results came out a little different.

Results for SKX
Bearish Harami
Elder Bar Turned Blue

Caveats - Of Course this is not the exhaustive list of possible setups or investing styles
StockCharts continues:

Philosophic Accuracy:
Scans are designed with a particular investing philosophy in mind. Value investors use scans that try to find weak stocks that are showing signs of a turnaround. Growth investors use scans that try to find stocks that have recently moved higher on strong volume. Short-term traders use quick, volatile indicators in their scans technical formulas while longer-term investors may use slower, less jittery indicators. And so on.

I assume they are using the default values for the technical indicators to achieve these results. If traders are using their own unique settings the search results would change. But it gives you an idea of  which stocks are on someones watchlist. If you change the time period you are changing the bars. The sensitivity will vary with the addition or subtraction of bars. This will affect the consistency and accuracy of the indicator. As a general rule if you want more sensitivity then
 - add more bars
- shorten the time period
- use EMA over SMA

Conclusion on Investing Styles
A good long-term investor uses technical indicators to get a good entry point. A good short-term trader uses fundamentals to get a solid stock to trade with. No matter what style of investing, your mood can vary from day to day; Good traders use what fits their personality/mood and what fits the market at the time to make money.

implied default probability

Photo by http://pauldunay.com

Funny what you can find on the Internet. I found a white-paper written in 2003 about Skechers (SKX) and it contained the same concerns then as there are today. Eight years later we are still starting another debate of where this company is in its life cycle. Is Skechers a badly managed mature company close to dying?

In valuation, there are several ways to determine how risky an asset is and the implied probability of default.

Looking at the market's interpretation of current sentiment and pricing
The easiest way is to look at the CDS, Futures & Swaps instruments for SKX. I couldn't find a free site and don't have access to asset-backed CDS Markit.com equities information. If someone knows of one, please tell me.
[edit: a good website to gather information on equity default swaps is  here
The whole idea of these swaps are to hedge. If you knew that Ford was undervalued and Chrysler is overbought; you want to bet only on that, not the rest of the economy, etc. So you want to hedge the relationship of Ford to Chrysler not the rest of the world; Therefore special dynamic swaps are borne and only their creators'  imagination limit these models...don't ask me how they do it....I'm just figuring it out as I go here. ]

The alternative is to do it by hand. Wikipedia describes backward induction as the following:

Backward induction is the process of reasoning backwards in time, from the end of a problem or situation, to determine a sequence of optimal actions. It proceeds by first considering the last time a decision might be made and choosing what to do in any situation at that time. Using this information, one can then determine what to do at the second-to-last time of decision. This process continues backwards until one has determined the best action for every possible situation.

Using backward induction you can establish the present value of current equity prices and interest rates. That is how futures and swaps estimate their value and quantify uncertainty and risk. Dr. Geanakoplos has a free Yale University course on YouTube about this.

On to easier methods....

Looking at valuation methods 
Dr. Damodararian has many free spreadsheets that can give a valuation of the company.
-evaluation of debt/equity ratios to create a synthetic beta (implied equity risk premium)
-evaluation of debt bond ratings to create a synthetic credit rating

A little bit easier....

The quick calculation method
The Altman Z-score is an insolvency predictor. It can be viewed at several website, usually in their premium sections. I did find it for free here. There also is a Z-score calculator I used to generate historical scores. There are five financial ratios used in the Z-Score with different weight factors.

An article from Armand Lucarelli

"No model predicts precisely when failure will occur, but the Z-Score has indicated that failure is likely up to two years before a company declares bankruptcy. The Z-Score should be reviewed over time rather than at any one point in time. The trend is important. The most serious changes in the ratios occur between the third and second years prior to bankruptcy."

The Interpretation of Z Score

Using Yahoo finance data and the calculator above I generated the following historical Z-Scores:

For 2010 annual data SKX was 3.60
For 2009 annual data SKX was 3.99
For 2008 annual data SKX was 4.08

With a Z-Score above 3.0, a company is considered safe based on their financial ratios.

Armand Lucarelli continues

"The lower the Z-Score is, the greater the odds are of failure. For publicly owned companies, scores between 1.81 and 2.99 are in the gray area — a company may survive if corrective actions are taken — while scores of less than 1.81 indicate that failure is a real possibility. For privately owned companies, the range for the gray area is lower — 1.23 to 2.90 — to account for the differences between book value and market value."

Change is Good

Things are really changing at SKX. A press release yesterday stated that

"Total Apparel Group, Inc. ("TAG") (OTC Pink: TLAG) today announced that its wholly owned subsidiary, Total Licensing, Inc. ("TLI"), has partnered with Glamm Industries, LLC ("Glamm") to develop and market timepieces for SKECHERS US"

Another licensing agreement with LF USA, a subsidiary of Hong Kong-headquartered multinational Li & Fung Limited, to produce a SKECHERS Fitness apparel and accessories collection for men and women.

"The SKECHERS Fitness Apparel collection will build on the success of SKECHERS Fitness Footwear, which now includes technical running collections as well as styles designed for training and all-day wear. LF USA’s Regatta division will design, produce, distribute and market the collection"

Along with Sketcher's new shoe line, it appears they are intent on increasing their revenue streams. I'm rooting for them.

Hurry Up and Wait Please

Photo by Karina Gerbst

My patience on Sketcher's (SKX) seems to be working. It was up nicely yesterday. The news from Nike (NKE) , Crocs (CROX), Timberland(TBL) et al are boosting interest in this sector.

Sketchers is a battered down value stock. Other than defining the idiom "A rising tide lifts all boats", what else is happening here? Well, I do see change. Sketcher's main customer Brown Shoe (BWS) had a good earnings report last week. I hope this is a sign that the stuffed inventory channels are thinning out. Sketcher's has its own e-commerce shoe website. Its shoe prices for their "Toner shoes" seem to have come down slightly. I am hoping that their new pricing is the adjustment needed to boost demand. Looking at the upcoming seasons, the "Back-To-School" and Christmas sales will help tremendously.

Sketcher's is the only publicly traded company that sells the "Toner Shoe" style. Reebok & Asics are the other main sources of this style of shoe and are privately owned. If you want a stake in this new market and you're not Warren Buffet who can buy the whole company when he likes an equity, then SKX is your only choice.


 The controversy seems to be that Sketchers is now trying to enter and compete within the crowded fitness shoe arena. “Skechers Fitness has grown from a single style into a performance running line, training line, and an everyday toning line,” Skechers President Michael Greenberg said in a statement. "The apparel collection will build on the company’s Sketcher Fitness Footwear line, which now includes technical running shoes as well as styles designed for training and all-day wear." The new line is coming in 2012.

According to SeekingAlpha

Sketchers’ current attempt to expand the recognition of its brand into other realms of footwear may invariably diminish the perceived and/or actual focus of the brand on providing products appreciated by loyal consumers. Skateboarders and individuals who wear toning shoes appear, at least at first glance, to be unrelated groups of consumers....

How can you rate the current sentiment?
Comparing the current quarter earnings to last year's quarter, the results will be more of a measure of progress than an actual beat; However, the current consensus is that there will be vast improvement in the last half of the year.

The next earnings report is July 25th. Barring an early press release announcement, what could you use to read the current sentiment on SKX? The July 2011 options expire on July 15th, before the reporting period and the August 2011 options expire after the report.

Using the premise that an option straddle is a hedged bet composed of calls and puts can a price range be defined by the break-even points? I would like to experiment with a weighted blend of prices for a range of options for the next 30 days. Just like the VIX, would you be able to find a range of prices, and actually measure the incremental wisdom of the total crowd? The VIX volatility index is used by options traders to calculate options premiums (i.e. options prices), and also by S&P 500 traders to determine the expected daily range for the S&P 500 stock index and futures market. Only I would be doing it for one stock. The math may be over my head. Need to do more homework....

It seems to be a very volatile range. Prior to yesterday's run-up the range was quite different than this morning. But a simplified historical range of stock prices might be a more powerful piece to the puzzle that I thought.

Overwhelmed by Scope Creep

I'm not going to impress anyone with my financial ratio analysis.  Or my valuations skills, either. I think my strong point is studying existing assumptions and exploring, through a trader's vantage point, what can be applied or exploited. So when I started to analyze the turnover ratio on SKX, I felt that I had just enough skill to verify the validity of the company's statements, but not enough to know if these factors were out of line with theoretical or practical experience. I borrowed heavily from the Nasdaq Guru site.

Things I know, Things I don't know and Things I don't know I don't know
Also, I think the next steps are:

• would be to do the same to Reebok, a "toner shoe" competitor
• analyze the larger customers of SKX,  such as Brown Shoe (Famous Footwear), etc.
• get retail sales data, if possible, or extrapolate
• analyze trends vs fads, life cycles, etc.
• analyze customer satisfaction
• quantitative analysis
• study other lines of shoes in SKX, including the expanding International sector
• find things I don't know I don't know
  

Overwhelmed
But then, as it is said in the computer industry, there would be "scope creep". I only need to find one trading edge to exploit a widely held misconception. So let's just start with the turnover.

The company management traditionally can only see clearly for the next 2 quarters. The high peak seasonality of Spring and early Summer is coming to an end. Let's see if the inventory improves for the next reporting period in July. After that we have the Back-To-School & Xmas season.


Management comments are from Mar 1, 2011 10K and May 9th, 2011 10Q data
First Step 
  From Management :

Our earnings and margins in the first quarter of 2011 were negatively impacted by several factors, including the sell-through of excess toning inventory that resulted from the domestic market being saturated with competitors’ lower priced toning product. Sales of lower margin product through our domestic wholesale channel and lower retail margins due to increased promotional activity caused by excess toning inventory levels contributed to lower earnings and margins in the first quarter.

We expect that the excess toning inventory will impact our net sales, margins, results of operations, and earnings per share during the remainder of 2011. However, we believe that new styles and lines of footwear that we will be launching later this year will have an offsetting positive impact on our results of operations in the second half of 2011.

Using http://www.vitalentusa.com/learn/turnover.php danger warnings in green paragraphs below:

1.

Advanced sales – An increase in sales in a given reporting period usually results in increased inventory turnover, but that increase in sales (and turnover) may be due to a temporary factor. If it were, then you would be wrong to conclude that the increase in inventory turnover means you are operating more leanly. For example, a sales jump in one period may reflect advanced purchase of items that are usually bought in the next reporting period.

Failsafe: Check several reporting periods to be sure that the increase in turnover resulting from increased sales is not due to advance sales or some other temporary factor. If the increased sales and improved turnover rate hold over several reporting periods, then it is probably not due to advance sales.

Nasdaq Guru site based on book by Motley Fool

INVENTORY TO SALES: [PASS]  

This methodology strongly believes that companies, especially small ones, should have tight control over inventory. It's a warning sign if a company's inventory relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Inventory to Sales for SKX was 15.60% last year, while for this year it is 19.86%. Although the inventory to sales is rising, it is below the max 30% that is allowed. The investor can still consider the stock if all other criteria appear very attractive. 

2.

Phantom sales – Sales made to a customer with the understanding that they will be returned for credit before payment is due.

Failsafe: To avoid this danger, you need to take two steps. First, check several reporting periods to be sure that the increase in turnover is not due to phantom sales. Also look for improvements in turnover in one period that are offset by a decrease in turnover in a subsequent reporting period as goods sold in the prior period are returned and re-entered into inventory. In addition to abnormal inventory turnover fluctuations, these phantom sales will typically result in an increase in accounts receivable as a percentage of sales. Thus, the improved inventory turnover will be offset by a decrease in accounts receivable turnover or the ratio of accounts receivable to sales.

Nasdaq Guru site based on book by Motley Fool

ACCOUNT RECEIVABLE TO SALES: [PASS] 

This methodology wants to make sure that a company's accounts receivable do not get significantly out of line with sales. It's a warning sign if a company's accounts receivable relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Accounts Receivable to Sales for SKX was 16.16% last year, while for this year it is 13.74%. Since the AR to sales is decreasing by -2.42% the stock passes this criterion. 

The management did mention that there were some customers returns that were affecting the financial statements.

3.	Discount-driven sales - Offering large discounts may also generate a boost in sales. Such discounts erode the company’s profit margins, but will boost revenue and rate of inventory turnover. The company might look like it is becoming more Lean, when in fact it may simply be pushing products into the marketplace using artificially low pricing.
	Failsafe: Watch the gross margins reported by the business. Gross margin is the difference between the dollar value of sales and cost of goods sold (also termed cost of sales). If inventory turnover is increasing, but gross margins as a percentage of sales are decreasing, then this may indicate a problem.

From management:

We anticipate our domestic revenues and margins will be lower in 2011 compared to the same period in the prior year as a result of reduced demand in the toning market. We will continue to aggressively work through our older toning inventory until customers’ demand is in-line with supply, which we anticipate will be during the second half of 2011.

Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices and potentially compromise the Skechers brand image.

One thing I did notice was that their website pricing on their women's toner shoes are not being discounted. However, other online sites channels are.

4.

Supplier-financed inventory – It is possible to reduce materials and supplies inventory and show improved inventory turnover by forcing your supplier to carry the inventory for you. The supplier assumes the cost of maintaining inventory and passes that cost on. Or, you may reduce inventory by use of express shipment or other costly means of delivery to ensure the availability of materials and supplies when you need them. Improved materials and supplies inventory turnover, in these cases, would not mean that you were operating more leanly.

Failsafe: To detect this shift of cost to suppliers, monitor changes in the unit cost of products that result from the increased cost of materials and supplies. Solutions to maintaining inventory that simply shift cost to suppliers return the cost in added mark-ups to the materials and supplies you purchase. This results in a rise in your product's unit cost.

From management:

Our cost of sales includes the cost of footwear purchased from our manufacturers, royalties, duties, quota costs, inbound freight (including ocean, air and freight from the dock to our distribution centers), broker fees and storage costs. Because we include expenses related to our distribution network in general and administrative expenses while some of our competitors may include expenses of this type in cost of sales, our gross margins may not be comparable, and we may report higher gross margins than some of our competitors in part for this reason. 

 

5.

Customer financed inventory solutions – Depending on your marketplace, it is possible to maintain low finished product inventory at the expense of your customer. In many marketplaces, competition is still not keen. You can survive— even grow, based on not being worse than your competitors. You can, for example, maintain low finished product inventory by having your customer wait for products forcing your customer to maintain higher inventory so he or she can sustain operations while waiting for your deliveries. In essence, you produce to order, not to need. When you are done, the product ships.

Failsafe: Use information on customer satisfaction with the availability of products and timeliness of delivery to balance your judgment about whether improving inventory turnover reflect true lean operations. If it is leanness that has produced the improvement, then customer satisfaction with availability and timeliness will remain high.

From management:

BACKLOG      

As of December 31, 2010, our backlog was $588.9 million, compared to $454.7 million as of December 31, 2009. Backlog orders are subject to cancellation by customers, as evidenced by order cancellations that we have experienced over the past few years due to the weakened U.S. economy and the toning market becoming saturated with lower priced products. 

 

6.	Waste inflated COGS – The cost of goods sold can increase due to total sales or because of increased rework or scrap. In other words, the same number of sales occurs but the cost associated with producing the products sold increases due to waste (defects, scrap, spoilage). When finished products are discarded because defects are discovered, the cost associated with that waste is captured in COGS. Consequently, the numerator of the Inventory Turnover ratio increases. Since the defective products are not in inventory, this waste also decreases the average cost of inventory, the denominator of the Turnover ratio. As the numerator increases and the denominator decreases, the ratio goes higher. It looks like you are operating more Lean— yet, you are actually operating LESS Lean.
	Failsafe: A remedy for this distortion is to extract from the COGS any expense due to manufacturing wastage. The formula would be as follow: (Cost of Goods Sold – Cost of scrapped and damaged items due to manufacturing) / average dollar value of inventory.

SKX and slow inventory turnover

Skechers USA, Inc. (NYSE:SKX)
The two well-known issues with this stock are:
Issue no#  1

1) A new lawsuit alleges that Skecher's Shape-up shoes can cause serious injuries. Another concern is that these shoes are being specifically targeted towards young girls who have self-esteem and body image issues. There is also some concern that these "toner shoes" are ineffective. 

In their 10K Risk Factors there is a description:

It Is Difficult To Predict The Effect Of Regulatory Inquiries About Advertising And Promotional Claims Related To Our Products In The Fitness Footwear Market.

It continues in the Legal Section:

We are currently responding to requests for information regarding our claims and advertising from regulatory and quasi-regulatory agencies in several countries throughout the world and are cooperating with such requests. While we believe that our claims and advertising are supported by tests, medical opinions and other relevant data and we have been successful in defending our claims and advertising in several different countries, in light of these regulatory requests, we frequently review and update our claims and advertising. It is too early to predict the outcome of the ongoing inquiries and whether such an outcome will have a material effect on our advertising, promotional claims, business, results of operations or financial position.

Controversy for the Greenberg Family was not shied away from in their earlier pursuits. I seem to remember L. A. Gear was flamboyant also.

Mr. Robert Greenberg has been the Chairman of the Board and Chief Executive Officer of Skechers USA Inc. since October 1993. From 1979 to 1992, Mr. Greenberg served as the Chairman of the Board, Chief Operating Officer and President of L.A. Gear Inc., which he founded in 1979.

Michael Greenberg has been the President and a Director of Skechers Usa Inc. since its inception in 1992, and from June 1992 to October 1993, he was Chairman of the Board.

Robert Greenberg started Skechers in 1992 after he left LA Gear, which he also founded.  Skechers makes an effort to maintain a trendy and stylish brand image by using celebrity-driven advertising. Many Skechers shoe designs are copies of other shoe designs with very good marketing.

---
How do you determine if inventory is slowing down?
Issue no# 2

2) A slow inventory turnover has been increasingly blamed on competition and customer order cancellations. Margins are down and inventory is up.

SKX has four reportable segments — domestic wholesale sales, international wholesale sales, retail sales, which includes domestic and international retail sales, and e-commerce sales. They evaluate segment performance based primarily on net sales and gross margins. The largest portion of their revenue is derived from the domestic wholesale segment.
    
Approximately 44% of their domestic wholesale revenues as a percentage of net sales are affected by the slow down. Approximately 19% of their retail segment is affected.

Although the "toning shoes" trend has only been around since 2009, the seasonality seems to be

"mainly a ‘white shoe’, toning has a seasonal peak through Spring and early summer and a huge peak around Xmas."

Alright, so I have three forecast on the of the relief to inventory.
The first one is dated from the second quarter of last year.
1) They confirmed what the market already priced, that...planning was a disaster by both retailers and SKX and Shape-up orders have been cancelled or pushed back and inventory will not be balanced until end of 1^st quarter. Company has seriously p off the analysts, so some will lose interest in this stock and stop marketing [it] to clients. Lack of transparency. [This] will result in a lower multiple than industry.

A more recent analysis says:
2) The company claims it'll have made significant progress by the third or fourth quarter....
and continues:
3) However, based on management's past track record, I think we'll really know after the holiday season, which puts us into the first or second quarter of 2012. At that point, the future of "Shape-Ups" and their bloated inventory – one way or another – will have played out.