Tuesday, December 28, 2010

Best Buy Overreactions

As a retailer of consumer electronics, Best Buy receives a disproportionate amount of income in the quarter which covers the December period. Consider the following graph, which depicts Best Buy's earnings by quarter and for the full year:

Clearly, the first three quarters play only a small role in determining the success of Best Buy's year. Despite this, the company's stock price fluctuates dramatically based on how well results in these quarters match-up with expectations.

For example, between the months of April and September of this year, the stock price traded between a range of $30 and $49 per share. Did the company's value really change by more than 60%, or is the market merely overreacting to some rather inconsequential quarterly reports?

I would argue the latter. Best Buy is an incredibly stable business, as shown by its return on invested capital levels over the last several years. Furthermore, Best Buy's streak of generating excellent returns continues, as its return on equity (ROE) over the last 12 months is 24%.

But because the market overreacts to quarterly misses, investors are offered great entry points for this stock. Two weeks ago, Best Buy reported operating income that was higher than it was last year, but that missed expectations. As a result, the stock fell dramatically; the company now trades at a P/E of just 8, based on its current market cap and its last 12 months of earnings.

Market overreactions with this stock are rather common. Long-term investors can take advantage of the situation by buying when the stock gets punished to low P/E levels, and selling when positive sentiment returns.

Disclosure: Author has a long position in shares of BBY


Andrew said...

Hey Saj,

I actually prefer RSH over BBY. I tried to exam why in a recent blog post http://whopperinvestments.blogspot.com/2010/12/bby-vs-rsh-why-im-going-with-rsh.html#more


Anonymous said...

I prefer BBY due to better sales growth and EPS growth over 10 years. RSY has gone nowhere in terms of sales.

Dominic Nadeau said...

Hi Saj

I was looping for an entry point in bby for a year now. After your article I wrote my analysis on BBY. Check it out pretoriainvestment.wordpress.com

Anonymous said...

Hey Saj,

I was also wondering if you had any opinion on UVE?

They have a lot of cash, a good dividend yield, and seems to be trading at low multiples. The insurance industry in Florida seemed to be hit with new regulations in 2010 though...


Saj Karsan said...

Hi Anon,

Insurance is out of my circle of competence for now, so I'm afraid I don't really have much of an opinion on UVE, sorry!

Chris said...

BBY has really taken a hit lately. Are you still holding and/or adding to your position?

I noticed that David Einhorn disclosed a sizable position in his recent investor letter. I am still bullish on the company.

BBY only has about ~$1 B left in its share repurchase program. I will be very upset if it isn't snatching shares and these depressed <$30 prices. The board should refund the buyback program.

Saj Karsan said...

Hi Chris,

Yes I still like it. I hope for buybacks as well!

Anonymous said...

Hi Saj,

Are you still invested? Do you think with old ceo gone, the new guy might be able to turned around the ship.

Saj Karsan said...

Hi Anon,

I do still like this stock. I believe the company has scale advantages; hopefully new management improves the situation.

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