Best Buy has soared an incredible 220% in 2013 alone, but despite these gains, some still believe that more upside could come. Therefore, is Best Buy still a good investment opportunity relative to its retail peers?
What's happened this year?
Best Buy's rally in 2013 has followed a combination of catalysts which began with the company's strategic plan of cutting costs to improve margins. Best Buy then got a boost from an online sales tax bill that put more pressure on individual states to tax e-commerce purchases. Thus, online competitors such as Amazon and eBay weren't as appealing to the consumer without that additional 4%-9% in sales tax savings.
While Best Buy's overall sales are yet to produce year-over-year growth, online sales have been a true bright spot for the retailer, growing 16.3% in comparable sales last quarter relative to the previous year . Lastly, partnerships with Apple, Microsoft, Samsung, and rumors of an agreement with Google to rent space within Best Buy's stores, have sparked investor optimism and has allowed the company to maximize its large presence.
Hence, it has been a great year for Best Buy, and its stock has responded nicely. But, is there still room for the big-box retailer to rally even higher?
A Reuters article that highlights the outlook of analysts who cover Best Buy concludes that the stock trades at a 17.3% discount to its peer average. According to the article, Best Buy at 14.4 times forward earnings is significantly cheaper than others in the industry. Thus, an average price target of $50 has been awarded.
Hence, If $50 is the target, and Best Buy is 17.3% cheaper than its peers, then I guess that settles the question of whether or not more upside exists, right? Well, not really. There is more to Best Buy's valuation than just a P/E ratio.
Sure, a P/E ratio might be the sexiest of Wall Street metrics, but in reality, it tells us little about the company's direction, and its room for improvement. Also, you must take into account that the companies being compared to Best Buy are likely at a different place in their business cycle.
Different type of retail
Is it really fair to compare a P/E ratio of Best Buy to companies like Wal-Mart or Amazon ?
Since Hubert Joly took over as Best Buy's CEO in September 2012, he has cut nearly $390 million in costs by eliminating management roles and closing unprofitable stores. This process makes Best Buy a turnaround company.
Wal-Mart is the ultimate cyclical company. In fact, its fundamental performance is perhaps the best gauge of economic health, having nearly $500 billion in annual revenue. Thus, should we be comparing this massive gauge of the economy to Best Buy on a price/earnings basis?
Then, Amazon with top-line growth of more than 20% annually, and a strategy that involves reinvesting revenue into the business to create future growth, makes Amazon a growth company. Thus, not comparable to a turnaround or cyclical company relative to earnings.
What's a better metric?
Instead of comparing earnings to determine a price target or upside, shouldn't we use a more practical metric to compare size and operational profits? I think so, because by looking at operating cash flow we can see how much a company earns from its operations alone, and then compare it to the valuation of the stock.
Moreover, by looking at annual sales we can create an idea of their market capitalization relative to the pure size of their business. Thus, if a company is cheap relative to sales, and operating cash flow, sometimes only minor changes are needed to produce a larger profit, indicating a higher level of value.
Price/Operating Cash Flow
Clearly, beyond a price/earnings comparison, Best Buy is significantly cheaper than both Wal-Mart and Amazon relative to sales and operating cash-flow. This suggests - based on last 12 months - that Best Buy does in fact have significant upside relative to the industry itself.
Now, Best Buy is not a clear-cut value stock with a likelihood to double over the next year. Instead, Best Buy is a project, and if the new CEO continues to execute his plan, and turn more of the company's operating cash flow into bottom line profits, then Best Buy could trade significantly higher.
Hence, Best Buy is still cheap, presenting a much deeper discount to sales and operating cash-flow, meaning a $50 target might be conservative.
The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.
The article Is This Top Retail Performer Cheap Relative to Its Peers? originally appeared on Fool.com.
Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. 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.
Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.