There are currently a number of retailers trading at low P/E's (e.g. below 10) that generate strong returns on equity (ROE). Value investors know that these are the kinds of stocks that generate strong returns over the long term. RadioShack (RSH), a consumer electronics retailer at shopping malls, strip malls and in kiosks, is another example of a retailer that appears to trade at a discount.
Unlike a few other retailers trading at low P/E's and high ROE's, however, RadioShack is no one-year wonder. Over the last business cycle, its operating margin has fallen below 6.9% only once (3.3% in 2006). Through the recent recession, operating margins were strong and stable, at 7.6%, 8.6% and 8.9% for 2008, 2009 and 2010, respectively.
Because of the company's retail successes in recent years, it has been building up its cash balance despite consistent dividends and occasional buybacks. RadioShack has $720 million of cash, which is about one third of its market cap. As such, the higher-ups have decided to buy back a ton of stock. RadioShack spent $300 million last quarter (which is about 15% of the company's current market cap) buying back shares. Seeing as how the company's P/E is about 9 (based on its current market cap divided by the sum of its last four quarters of earnings), further buy backs at these prices could turn out very well for shareholders.
Investors may already have a bias towards certain competitors of RadioShack in the consumer electronics retailing space. For example, hhgregg (HGG) has shown strong revenue and earnings growth over the last several years, making it a favourite among growth investors. At the other end of the spectrum, strong and steady Best Buy (BBY) has attracted the attention of value investors with its low P/E.
But the important thing to realize is that there are enough spoils to go around. Every retailer will have short-term issues that have the potential to affect the stock price (For RadioShack at the moment, for example, that could be iPhone cannibalization and the loss of Sam's Club kiosks.) But the products being created for consumers, from internet and 3-D tvs to tablet computers to smartphones to video gaming innovations will keep this space growing for years to come. As such, all of these financially healthy companies (unlike Circuit City) appear likely to maintain or grow their profits. Therefore, value investors needn't choose between RadioShack and Best Buy; the fact that both are cheap allows investors to lower their risk by diversifying across the two companies. When the negative sentiment towards this industry and these companies abates, value investors will profit no matter which company posts relatively stronger results.
Disclosure: Author has a long position in shares of BBY and RSH