Susan Easton: The Uggly truth - Fund managers are too square

Ugg boots have taken off in the US. Photo / NZ Herald

What's the first image that pops into your head when you think of Ugg boots? Probably not the tan-coloured, sheepskin-lined boots themselves.

More likely you're thinking of the girl wearing the boots. Her name might be Rochelle, or Charlene, or Mikaela.

She's in her 20s, blonde hair and tight jeans, scuffing out of a suburban shopping mall near you.

But a strange thing happened about five years ago. Ugg boots started popping up in glossy magazines, warming the A-grade feet of celebrities like Kate Moss, Sarah Jessica Parker and Jennifer Aniston.

Even Oprah recommended them as a Christmas gift. Suddenly, Rochelle and Mikaela weren't just fashionable, they were fashion leaders. Lower Hutt was 10 years ahead of Hollywood.

How the heck did this happen? To be honest, our friends over the ditch probably had more to do with Ugg's rise than Rochelle or Mikaela.

While the origins of Uggs are hotly disputed, many believe they were invented by Australian surfers to keep their toes warm after spending all day in the water. And it was an Aussie surfer, Brian Smith, who took the boots to the United States in the 1980s.

The boots enjoyed a niche in Californian beach communities but it wasn't until Smith's Ugg brand was bought out by a US company, Deckers Outdoor Corporation, that sales really took off.

From the late 1990s, Deckers took an educated punt and began marketing Uggs as fashion footwear, not just comfy boots to slop around in. Success took a while to build but by the early 2000s, the brand revamp began to pay off, big time.

In 2002, Deckers' Ugg sales were a modest $24 million. By 2009, that figure had grown to $711 million and this year, sales are on track to exceed $800 million.

No longer a niche product, Uggs are advertised in magazines like Vogue, Marie Claire and In Style; they've appeared in TV shows like Entourage and The Sopranos; and they've featured in countless articles trumpeting the unlikely success of the furry footwear.

There are now over a hundred different styles sold under the patented Ugg brand, ranging from slippers to high-heeled boots. Judging by the number of fakes sold over the internet, Uggs have well and truly arrived.

Deckers is scuffing all the way to the bank. Its share price has risen from $1.40 in 2002 to over $45 today - which tells you that almost no one saw the Ugg juggernaut coming.

From an investment perspective, there are two key takeaways from the Ugg story. First, Americans are brilliant marketers who understand what celebrity endorsements and smart product placements can do for a brand. And second, equity markets are hopeless at predicting popular trends. Really hopeless.

This failing doesn't just apply to apparel. When Frucor listed in New Zealand with V as its signature brand, a lot of fund managers turned up their noses, dismissing energy drinks as a passing fad despite overseas evidence to the contrary.

How wrong were their oh-so-wise predictions? Frucor's listing in 2000 valued the company at $187 million. Eight years later, it was bought by a Japanese company, Suntory, for $1.3 billion. Such mistrust of new trends is understandable. Investment professionals aren't particularly hip or happening people - they are far more comfortable forecasting coated paper volumes than trying to second guess the whims of teens and twentysomethings.

So when it comes to stocks that rely heavily on consumer tastes, they prefer the tried and true - like Nike or Apple - to the up and coming. Even when a brand or product has strong momentum and a multi-year track record of growth, institutions are often late to the party.

Deckers is a case in point. Today, the company's market cap stands at just under US$2 billion ($2.7 billion) - not big by American standards, but not a tiddler either. Its earnings growth over the past three years has averaged 40 per cent and this year it is on track for more than 20 per cent in a pretty crappy year for retail.

Deckers is flush with cash, the management team is stable, and its expansion into markets outside of the US has only just begun. So why does it trade on a price to earnings ratio of just 12.4 times, implying its growth has largely matured?

Imminent market saturation, some analysts say. The fad won't last. Too much uncertainty. In other words, the same things they were saying five years ago, when Deckers' share price was a 10th of what it is today.

Whether Uggs can conquer Europe and Asia like they did the States is up for debate. So far, seemingly so good. But one thing's for sure, if they do succeed and Deckers' share price doubles, that's when your fusty old fund manager will start thinking about buying.

Gareth Morgan Investments (GMI) does not currently hold, or intend to hold in the foreseeable future, Decker shares. GMI makes no representation about the suitability of Decker shares for inclusion in an investment portfolio.

* Susan Easton is an investment analyst with Gareth Morgan Investments.