Our Focus List Stocks: Short Model Portfolio outperformed the S&P 500 as a short portfolio by 36% in 2021 with 29 of our 31 picks outperforming the index. This is the last of three reports examining the biggest winners from this model portfolio last year and their potential returns for this year.

Koss Corp. (KOSS) has outperformed as a short in 2021 and we remain bearish on the stock.

Priority List Stocks: Short Outperformed in 2021

The Focus List Stocks: Short Model Portfolio contains the best of our danger zone selections and leverages our fundamental data.

The Focus List Stocks: Short Model Portfolio fell an average of -16% in 2021, compared to an average return of 20% for the S&P 500, according to Figure 1.

Figure 1: Priority List Stocks: Short Model Portfolio Performance for Period Ending 4Q20 to 4Q21

Because our Focus List Stocks: Short Model Portfolio represents the best of the best picks, not all of the Danger Zone picks we publish are part of the model portfolio. We published 46 Danger Zone reports in 2021, but only added 11 of these picks to the list of Focused Actions: Short Model Portfolio during the year. Currently, the Focus List Stocks: Short Model Portfolio contains 28 stocks.

Figure 2 shows a more detailed breakdown of the model portfolio’s performance, which encompasses all stocks that were in the model portfolio at any time in 2021.

Figure 2: Performance of stocks in the Focus Actions list: short model portfolio in 2021

The performance includes the performance of stocks currently in the Focus Stocks: Short Model Portfolio list, as well as those removed during the year, which is why the number of stocks in Figure 2 (31) is greater than the number in actions currently in the model. Wallet (28).

Winner: Focus List Stocks: Short: Koss Corp. : down 54% vs. S&P 500 up 13% since added to focus list in 2021

We originally added Koss Corp. to the Focus Stocks: Short Model Portfolio list in June 2021, and from then through the end of 2021, it outperformed as a short by 67% in 2021. As the meme stock rally ages, Koss remains significantly overvalued. We have also warned investors of the risks of investing in other meme stocks such as GameStop (GME), AMC Entertainment (AMC) and Express, Inc. (EXPR).

Main reason for the short outperformance: the Meme-Stock rally ran out of steam: Koss rose to popularity in January 2021 among the Wall Street Bets Reddit crowd and was completely swept up in a meme stock rally that saw his stock jump from $3/share to $64/share. As with all meme stocks, the fundamentals of Koss have nothing to do with the stock’s rise. Once the meme wave died down, Koss’ actions fell to earth.

Why Koss remains very unattractive: Companies can’t justify the current valuation: Even though Koss has never traded on fundamentals, when we analyze his fundamentals and juxtapose them against the expectations embedded in the stock price, we see a big disconnect.

The retail dollar value of global headphone shipments has increased 30% (vs. -8% for KOSS) compounded annually since 2016. Meanwhile, Koss’s revenue has fallen 6% compounded annually during of the same period.

In other words, Koss’s revenue fell 28%, while the retail dollar value of global headphone shipments increased 273% over the same period. If Koss can’t increase his income in such a good environment, one has to wonder, when will he?

Koss’ revenues have been deteriorating for many years, and its profitability is also lower than that of the competition. Of the competitors in Figure 3, Koss is the only company with a negative NOPAT margin and ROIC. In fact, ROIC and NOPAT margins have been negative every year since 2016.

Figure 3: Profitability Indicators: Koss vs Peers: TTM

The current price implies profits 6x the previous quarterly record

We use our inverse discounted cash flow model to quantify future earnings growth expectations embedded in the current stock price and see what the stock would be worth assuming more reasonable growth.

To justify $10/share, Koss must:

• immediately improve its profit margin to 4% (double its highest margin of 2% TTM versus a 5-year average margin of -2%) and
• grow revenue by 24% compounded annually through FY 2027 (which is more than 2x projected industry growth over the same period compared to Koss’ five-year CAGR of -6% last years).

In this scenario, Koss earns $3 million in NOPAT in fiscal year 2027, which would be the company’s first-ever positive annual NOPAT and 6x its highest quarterly NOPAT ($0.5 million in 4Q21). ).

There is a downside of 60% or more if growth hits the industry average: In this scenario, Koss:

• improves its profit margin to 4% and
• increase revenue by 11% compounded annually through FY2027 (equal to projected industry growth over the same period), then

the stock is worth just $4/share today – a 60% drop from the current price. If Koss’ revenues continue to decline or it is unable to improve its margins as assumed in the above scenario, the stock’s downside risk is even higher.

Figure 4 compares the historical NOPAT and the company’s implied NOPATs for the two scenarios we have presented to illustrate how high expectations for Koss’ stock price remain.

Figure 4: Koss Historical and Implicit NOPAT: DCF Valuation Scenarios

This article originally published on January 18, 2022.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation for writing about a specific stock, industry, style, or topic.