Why is Conn's Trading Higher?

Source: Wikimedia Commons by Conn's Inc. 

Conn's is trading higher by over 9% today on heavy volume after two company insiders disclosed large stock purchases. The consumer electronics retailer's growth supersedes peers like Best Buy and hhgregg , but its stock has been hit hard this year with losses of nearly 50%. And while two insiders saw value in the beaten down stock, the real question is should you?

Significant insider activity
W.R. Stephens and Elizabeth Campbell are both already major owners at Conn's, and on Tuesday the company's stock reacted to news of more than $11 million in stock purchases between the two insiders. Specifically, Stephens bought 152,746 shares while Campbell purchased 106,034 shares.

In retrospect, Stephens and Campbell have been fairly wise in their activity over the last year, selling a combined $51.6 million in stock priced at $51.61 in June 2013. Stephens then sold $21 million worth of stock at $60 in July . Therefore, Stephens and Campbell aren't afraid to make big moves depending on the price action of the stock.

What about the fundamentals?
While insider buying is encouraging for retail investors, it's not always a sign to buy. This is because although insiders do understand their business better than the average investor they can't predict the long-term trend of the stock, nor can they foresee all possible operational problems. Thus, strong fundamentals have to be present!

With that said, Conn's looks rather impressive at first glance. Over the the company's last year its revenue grew 38%, which was sparked by an impressive 26.5% growth in existing stores. In comparison to Best Buy, Conn's looks far superior, as Best Buy's revenue declined 13.4% in its last quarter, and its comparable sales saw a 1.2% drop . If you compare Conn's to hhgregg, it looks even better, as hhgregg is a company that recently announced expectations for a 9.9% decrease in comparable sales for its fiscal fourth quarter, driven by a near 19% drop in its consumer electronics department .

What this means is that Conn's is growing while its peers are not. Also, the company is profitable, seeing its gross margin increase by 370 basis points in its last quarter. Thus, with a near 50% decrease in share price so far this year, coupled with a high earnings growth rate and a trailing P/E ratio of only 17 some might see it as a great opportunity.

2 questions to ask
Before you jump on the Conn's wagon, there are two questions you need to ask as an investors. First, Conn's has been in business for nearly 60 years, so why is it all of a sudden seeing so much growth? Second, Conn's sells many of the same products as Best Buy and hhgregg, yet there is a large disconnect in the growth rates, what is the reason for this?

The answer to both these questions is the growth of the company's in-house credit program. Conn's decision to offer credit to consumers has sparked extremely fast growth, leading to large gains in 2012 and 2013, but in 2014 delinquencies have begun to rise, which is why the stock has fallen nearly 50%.

Conn's credit balance ended last year at $1.07 billion, a 44% increase over the year prior, which essentially shows that all of Conn's growth is coming from credit, customers who may not pay their bills. While this fact may alarm some, the real scary part is that account balances 60 days or more past due rose 78% in its last quarter, which has occurred due to Conn's having very flexible requirements as to who it finances. Naturally, this large credit balance becomes debt, and if consumers don't pay, this segment that made the company's growth rate possible could possibly bankrupt Conn's.

Final Thoughts
In the face of a highly competitive market, there's a reason that Best Buy and hhgregg haven't followed Conn's with a large credit program. Essentially, the risk is too large.

For Conn's this program works great when consumers are paying their bills but when defaults start to rise the company could find itself in hot water. With a credit balance that nearly matches its total revenue last year, and 8.8% of its total account balances being 60 days or more past due, Conn's is a rather risky investment. Foolish investors would do well to weigh these risks carefully before initiating a position. 

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The article Why is Conn's Trading Higher? originally appeared on Fool.com.

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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