Tile Shop Hldgs, Inc. Stock Down 17% on Downgrade: Here's What the Sellers Are Missing

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What happened

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Shares of specialty home-improvement retailer Tile Shop Hldgs, Inc. (NASDAQ: TTS) are down 16.5% at 12:20 p.m. EDT on Sept. 27 following a downgrade of the stock by Piper Jaffray analyst Peter Keith, who lowered his rating on the stock from "overweight" to "neutral" on concerns that the company's efforts to transition its product lineup has it headed straight for a poor second half of the year. 

According to the analyst note, Tile Shop's product transitions "generate uncertainty" for the company, adding to concerns for some investors following a second quarter that fell short of expectations. 

So what

Tile Shop's stock is down more than 43% from its 2017 peak at this writing after a disappointing second quarter and now this downgrade by Piper Jaffray. That's quite painful for anyone who bought shares at any point in the first half of the year. And to some extent, the company has "earned" some of this beat-down, falling short of expectations on both revenue and same-store sales growth and lowering its full-year guidance as a result. 

Speaking of "short," the number of Tile Shop shares held short was over 10% in late 2016, and was still near 6% as last reported. That's a relatively substantial amount of short interest in the company, and has almost certainly played a role in driving the price down at the end of the second quarter and after today's downgrade. Bad news can give short-sellers an easier exit point to lock in their profits. 

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Now what

It's been a tough year for Tile Shop investors, who've seen as much as 44% of their investment evaporate in months. That can happen when a stock like Tile Shop -- which traded over 50 times trailing earnings heading into second quarter's earnings report -- falls short of Wall Street's expectations. It's also worth noting that today's downgrade wasn't a "sell" recommendation by the analyst but a drop to "neutral" and a lowering of his price target to $14. Considering that shares trade for $12.25 at recent prices, does that make it a buy today in the analyst's view? 

In all seriousness, investors must remember a couple of important points. Analyst price targets, upgrades, and downgrades are almost always short term in nature. In this instance, Keith's projections are entirely based on his expectations for the second half of 2017. And if there's one thing stock investors must acknowledge, it's that short-term projections on stocks are nearly impossible to predict with consistent accuracy. That's why Foolish investors think and act based on long-term prospects. 

Tile Shop's business also continues to perform quite well since CEO Chris Homeister took over a few years ago. Debt is down. Cash flows have steadily improved. Margins are up. Store employee turnover has fallen substantially. Recurring sales to tile professionals have steadily increased. Management is accelerating the rate of new store expansion (and funding it from cash flows, not debt). In other words, its long-term prospects remain quite good. 

So while Mr. Market pays too much attention to very short-term things, long-term investors may do very well to consider opening or adding to their position in the company after the price drop.

In a few years, you may want to send Mr. Keith a thank-you note for the buying opportunity.  

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Jason Hall owns shares of Tile Shop Holdings. The Motley Fool recommends Tile Shop Holdings. The Motley Fool has a disclosure policy.