Ross Stores Is a Victim of Valuation

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For off-retail department store chain Ross Stores , the year's successes came to a grinding halt as the company delivered third-quarter earnings that surpassed expectations but failed to achieve the Street's projected guidance figures. Shares dropped nearly 7.5% after a 10-month, 50% run-up that had the apparel retailer as one of the top performers in the industry. Top- and bottom-line sales grew, same-store sales grew, and things are projected to continue growing (albeit at a lower rate than originally suggested). So, the question for investors is whether Ross' tepid guidance is indicative of a longer-term slowing, or just a macroeconomic-induced blip in an otherwise attractive business.

Earnings recap
Sales rose 6% to $2.4 billion in Ross' third quarter. Analysts had wanted slightly more, but the number was more or less on point. On the bottom end of the income statement, the company delivered above both internal and Wall Street estimates, with $0.80 per share. In the year-ago quarter, Ross earned $0.72 per share.

Same-store sales rose 2% -- not a tremendous gain but admirable considering the comp quarter posted a 6% rise.

Given the stock's big-time rise this year and ambitious goals baked into its price, investors and analysts were none too pleased to see forward EPS guidance that came in several cents lower than expectations and with just 1% to 2% same-store sales growth. Management predicts between $0.97 and $1.01 per share for the fourth quarter, whereas analysts wanted $1.09 on average.

We all know that quarterly expectations are incredibly myopic events and should not be near the paramount of a business evaluation, but do Ross' forward-looking statements suggest the company was overly optimistic?

Ross markets to a lower-income customer base -- one that is very sensitive to shifts in the economy. While 2013 wasn't a terrible year, the overall consensus appears to be continued thriftiness in consumer-spending habits while the economy grows painfully slowly. Ross was coming off a fantastic year (when compared to the year before it and so on), and the market applauded. In its generosity, the market valued Ross with little room for unforeseen events. Even today, the company trades at more than 17 times forward earnings. Industry giant Macy's trades at under 12 times earnings, while high-end player Nordstrom sits at 15 times earnings.

Investors may want to view Ross' tepid guidance and the recent stock sell-off as a typical reaction to prolonged market hype, and not so much a stutter in the operating business.

Ross is a good business that's run well, but the stock had little headroom. Either wait for performance to catch up to estimates, or let the stock price come back toward the realm of reason.

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The article Ross Stores Is a Victim of Valuation originally appeared on

Fool contributor Michael Lewis has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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