After Reaching Multi-Year Highs, Is This Retailer Still a Good Buy?
On Tuesday, shares of Best Buy surpassed $40 for the first time since 2010, after Cleveland Research noted "encouraging " sales trends for the third quarter. While comparable sales growth of 1%-2% apparently has investors excited, at some point valuation must be considered. With that said, is Best Buy still a good buying opportunity?
An ever-changing model
As investors, it's important to realize that the value of a company's stock is nothing more than a reflection of current and future earnings expectations. Sometimes we make investing more difficult than it should be, but perhaps a good way to determine fair value is to compare a company's fundamentals to years prior when priced the same.
Last 12 Months
Debt to Assets Ratio
Operating Cash Flow
Best Buy clearly has areas of strengths and weakness relative to 2010. Its revenue has declined slightly and its margins are lower, but its operating cash flow is higher. There have been many changes to the nature of Best Buy's business, however, and this has consequently led to the differences in the two years.
For one, Best Buy's competitor Amazon has added more than $30 billion in annual revenue between 2010 and the last 12 months . Amazon has essentially doubled in size. During that same period, Amazon's net income has gone from $1.15 billion to negative $100 million as the company implements goods with breakeven pricing.
This fact has affected Best Buy, a company that has been forced to lower costs and offer price matching with the likes of Amazon. In many ways this gives Amazon an unfair advantage, as Best Buy has more square footage that it has to heat, pay taxes on, and keep the lights on in. This all makes it harder for Best Buy to match such low prices.
With that said, Best Buy may lag with pricing - as it relates to margins - but it has gained with the addition of online sales tax. Earlier this year, the U.S. Senate voted 75-24 in favor of a non-binding resolution that backs online sales tax, as e-commerce now accounts for more than 5% of all retail . Best Buy has gained with this new legislation, as its online sales have posted double-digit growth in each quarter this year.
In addition, this bill may reverse a trend where an estimated 20% of all consumers who purchase electronics at Amazon first test the products in-store. Best Buy's price matching along with online sales tax have likely helped to reverse this trend, and has Best Buy expecting long-term growth.
Which is better now?
Clearly, much has occurred over the last couple years. Does this mean that Best Buy is in fact a "buy" now? To answer that question, comparing the company to another that sells similar products and also offers price matching might be beneficial in understanding how the market is valuing such companies, based on future expectations. To do this, we turn to Staples .
Staples is very much like Best Buy, selling office products and consumer electronics. When we compare the two companies side-by-side, we see that they are in fact very similar. Staples trades at 11.4 times next year's earnings with a price/sales multiple of 0.42. Best Buy trades at 15 times its forward earnings and 0.28 times sales.
Because of this, these two companies are valued in a similar manner. One striking difference is that Staples is seeing a greater degree of fundamental declines. During its last quarter, Staples saw a 2% revenue decline, but more importantly, a near 15% loss in net income . As a result, margins declined.
Moreover, Staples has operating margins of 6.1 %, but now with price matching it's tough to imagine a scenario where those margins are sustainable since similar companies are barely breaking even. It appears that Best Buy is better valued for the reality of a price-matching retail environment.
For consumers, it is awesome that Amazon has grown in size and changed the pricing landscape in retail. After returning gains of 250% in 2013, however, the question is whether or not Best Buy is still a good investment in this new environment that is significantly different versus 2010.
To me, a Best Buy that is less leveraged with debt, has higher margins, and is profitable has greater upside when priced at the exact same point. In many ways, this is exactly what we have encountered as we compare 2010 to the last 12 months.
With that said, online retail sales and Best Buy's decision to actually rent its square footage to the likes of Apple, Samsung, and Google shows a willingness to innovate and make change in an evolving retail environment. With a market cap of nearly $14 billion, however, Best Buy might be too expensive to bet on the fact that these changes will pay long-term dividends to investors.
Therefore, understanding the premium on shares of the company and proceeding with extreme caution is well advised. Sure, Best Buy has reached multi-year highs, but investors must realize that this is not the same company as in years past. Hopefully, new initiatives will spark growth for the company. Until that growth is realized, though, Best Buy looks to be risky right now.
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The article After Reaching Multi-Year Highs, Is This Retailer Still a Good Buy? 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 and Staples. 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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