What Has Bon-Ton Soaring Higher

Bon-Ton Stores traded higher by a whopping 40% in the two days following the company's third-quarter report. At first glance, the report does not look strong, but the stock performance that follows is a good lesson on what drives value in the market.

A fundamental glance
Bon-Ton is a department store operator in the U.S., selling an assortment of brands that appeal to a variety of consumers. The company is valued at $400 million, trading with losses greater than 60% since before the recession.

Its main problem has been a combination of low margins and a high debt load, which has made Bon-Ton one of the most heavily shorted stocks in the market.

With that said, the fact that Bon-Ton performed so well following earnings might have something to do with its high short interest, as such stocks have the potential to reverse quickly when or if shorts cover their borrowed shares.

If we look at the company's quarter, it's hard to identify what created the excitement. The company saw its total sales decline 2.6% year-over-year, which was a result of a 2.8% decline in comparable-store sales.

The company did improve its operating income by $5 million to $15.9 million. However, the quarter was still unprofitable.

Growth is not created equally in the stock market
In comparison, we've seen countless retailers announce earnings this season, many with strong comparable-sales growth but which did not trade higher or did not trade with the same level of gains.

For example, Macy's , a similar yet larger company, saw its comparable sales grow 3.5% and expects such growth to continue throughout the remainder of this year. The company also saw its net income grow 22%, significantly outperforming revenue. Yet its stock only increased 10% after earnings, although it has climbed 13% since the quarterly report.

On the other side of the spectrum, Best Buy saw its U.S. comparable sales grow 1.7%, much greater than Bon-Ton, and its stock declined 6%. Target , a large retailer and a great gauge of retail strength, saw comparable-sales growth of 1% in its last quarter, yet its stock declined 4%.

What creates gains?
Clearly, Bon-Ton has had the worst fundamental performance of the noted companies but has seen its stock surge, by far, the most. But the big question is why.

The answer lies in valuation, and in a market that has disregarded the value of a company in several industries, it is a good lesson to remember.

Now, as I said, Bon-Ton is barely profitable, having a profit margin of 0.3% over the last 12 months. Therefore, compared to the likes of Macy's or Target, you really can't compare P/E ratios, because the level of profit is so disconnected.

Moreover, in an industry with heavy discounting, being a high-margin company actually poses a risk, as much of a company's valuation is based on its ability to maintain margins. Thus low-margin companies that already discount heavily become attractive.

With that said, take a look at the noted companies' valuation relative to annual sales:

Take a look at how cheap Bon-Ton is compared to its peers. The only company that comes close is Best Buy, and it has seen stock gains of 240% in the last year with near-zero growth.

With that said, you might wonder why sales are important in valuing and assessing upside potential for a stock. The answer is that sales are the fundamental driver for all companies: Margins, cash-flow, and all profits are created from sales. Therefore, revenue itself is the main building block to any company's future.

Companies that trade at higher multiples to sales often earn more profit per dollar. Case in point: Macy's has an operating margin of nearly 10% while Best Buy's is only 2.4%. In the case of Bon Ton, it is selling many of the same items as Macy's but trades at a considerable discount.

This discount and the third-quarter margin improvements are why Bon-Ton has seen gains of 40%. And since it is so much cheaper than its peers, expectations are lower, which then means that stock gains are greater.

Final thoughts
With the markets sitting at all-time highs, investors must remember that momentum stocks with higher margins and greater premiums to fundamentals also have higher expectations. Theoretically, the market or a stock will rise until expectations become too high, which then causes expectations and the stock to trade lower.

Hence, Bon-Ton is still cheap with low expectations, and this fact means that it might actually be a good retail investment opportunity now.

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The article What Has Bon-Ton Soaring Higher originally appeared on Fool.com.

Fool contributor Brian Nichols 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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