Is Deckers Outdoor a good stock to buy?

“Your goal as an investor should simply be to acquire, at a reasonable price, some interest an easy to understand business whose earnings are virtually certain to be significantly higher five, ten, and twenty years from now.” (emphasis added) — Warren Buffett, 1996 letter to Berkshire Hathaway shareholders.

Outdoor deckers (DECK -1.36%) it’s a beloved stock right now. It owns popular shoe brands such as Hoka, has been included in the S&P 500 in March and recently had a 6-for-1 stock split. But I think investors are better off looking at Deckers because it’s a simple, easy-to-understand business — the kind Warren Buffett said investors should to look for him.

Here are some important things to note about Deckers’ business and some thoughts on future earnings, a key aspect of Buffett’s advice to investors.

What to know about Deckers

Deckers owns many shoe brands. Its big four are Ugg, Hoka, Teva and Sanuk — each brand has a slightly different target, from running shoes to sandals and more. This gives Deckers broad exposure to the footwear market rather than just targeting a specific category.

Deckers sells its shoes through wholesale partners. It also sells directly to customers through its e-commerce portals and in its own stores (less than 200 retail locations worldwide). In fiscal 2024 (which ended in March), 43% of sales were direct, while the rest came through wholesale channels.

Deckers has no control over how these sales are split. People like to buy things online, but they also like to try on shoes in person. Sometimes I shop online before trying them on in a store. Other times, the reverse is true.

The point is that Deckers needs its wholesale partners even though it has a strong direct-to-consumer operation. Meanwhile, competitors such as NIKE has leaned too much into e-commerce in recent years, giving up shelf space. Deckers was a direct beneficiary of the misstep, gaining some market share.

As the chart below shows, revenues for Deckers have been growing at an impressive rate in recent years.

Data by YCharts.

One of the good things about this business is that the shoes are universally adopted by consumers. In addition, they wear out regularly and need to be replaced. Therefore, Deckers is in a somewhat recession-proof industry. As long as it can remain present in people’s minds, it should enjoy a basic level of demand. And if it can continue to take market share, demand will increase.

This is really an easy business to understand.

Will Deckers’ future earnings be significantly higher?

Buffett also advises investors to consider whether a company’s earnings will be higher in the future. When it comes to Deckers, this might be a somewhat complicated question to answer.

As of this writing, Deckers’ revenue is growing. This sales growth lifted its gross margin and net margin to all-time highs.

Data by YCharts.

With margins at these levels, it’s worth asking the question: Has Deckers made material improvements to the business, or is it simply enjoying a temporary boost in profits due to recent revenue growth?

If management were to improve the business, then it should be possible to maintain these record margins, which would underline the case for buying Deckers stock. But if cyclicality drives demand above supply, then its profit improvement could only be temporary.

With this in mind, Deckers’ profit margins are likely to take a step back in the coming years. The company benefited from selling shoes at full price and also increased prices due to inflation. However, some inflationary pressures on the supply chain have eased.

Management also expects gross margin to decline from nearly 56% in fiscal 2024 to 54% this year, so that margin concern is already materializing. Furthermore, investors should consider that the economy has been relatively stable. If economic conditions worsen, then we would expect the company’s growth and profitability to decline to more normalized levels.

So could Deckers’ sales be higher five years from now? Yes, this is definitely possible if it continues to take market share from competitors. Can his earnings be higher? Yes, this is also possible. But if margins contract, then earnings may not material superior.

This would be less of a concern if Deckers shares were trading at a bargain valuation. But at 31 times earnings, it’s expensive for a shoestring stock, and that valuation is close to the highest the company has seen in five years.

To return to Buffett’s quote, investors cannot be “virtually certain” that Deckers’ earnings will be significantly higher in five years. As a result, its high rating is a cause for concern. Of course, Deckers is a good business that has posted strong earnings in recent years, but there may be better investment options for those looking to buy the stock today.