Back Up the Truck on Liz Claiborne

With the economy in a tailspin, the apparel business of Liz Claiborne(LIZ Quote - Cramer on LIZ - Stock Picks) is obviously going to struggle in the short term. So what should a prudent investor do? Buy the stock. The market already knows Liz is facing a problematic retail environment, and most of the potential negatives are factored into the stock price.

A quick back-of-the-envelope calculation provides enough rationale for bargain hunters to take a close look at Liz. Historically, the average price-to-earnings ratio for Liz is in the 13 to 15 range, while the absolute low is 8.6. Even after factoring in recent reductions in earnings forecasts, projected 2002 earnings of $4.30 put the stock's P/E in the neighborhood of 8.6, a historic low.

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Let's assume profit margins drop below historic lows and earnings are, say, $3.50 a share in 2002. Applying the trough multiple of 8.6 yields a stock price of $30, or roughly 20% less than the current quote. This is a reasonable risk for the prudent investor to take, given the potential reward.

And the reward is ample. With earnings power north of $5 a share in 2003 or 2004, a normal valuation range for Liz's shares plants the stock firmly in the $65 to $75 range, well in excess of the current quote.

A close look at the business model and financials of Liz reveals a wide margin of safety for long-term investors:

Liz is a veritable cash machine, consistently generating huge amounts of free-cash flow. About $200 million of free cash was generated in the last year vs. a current market cap of $2 billion.

Net current assets exceed all debt by $215 million.

Liz has a diversified portfolio of brands, with less fashion risk than one-brand companies such as Nike(NKE Quote - Cramer on NKE - Stock Picks), Tommy Hilfiger(TOM Quote - Cramer on TOM - Stock Picks) and Nautica(NAUT Quote - Cramer on NAUT - Stock Picks).

The current rollout to all Target(TGT Quote - Cramer on TGT - Stock Picks) stores of the Meg Allen brand is one of several initiatives that has dropped dependence on the department store channel to about 50% of sales.

Liz is consistently viewed by industry observers as having a superb management team.

Liz has a wide demographic and geographic customer base.

Liz has a history of managing capital for the benefit of shareholders, with $1.3 billion returned to shareholders via dividends and share buybacks in the past six years.

If you are a believer in cycles, as I am, you have to believe brighter days are ahead for the apparel industry. When a market leader is priced at a trough valuation, like Liz, in the midst of a difficult environment, investors have to take note. Opportunities like this are rare.