Tuesday, June 29, 2010

Best Buy Gets Sold

Following sub-par first quarter results, shares of Best Buy (BBY) have fallen to a level such that its P/E is now 11. Unlike some of the other low P/E stocks we have discussed on this site, however, Best Buy generates returns on capital of around 20% per year. And it does this consistently, as shown by the chart below:

What likely helps Best Buy maintain such steady returns is the nature of its competitive advantage. Unlike companies that have to continually invest to maintain their advantages (e.g. pharmaceuticals, smart-phone makers etc.), Best Buy gets to profit off of the product innovations of others, by relying on its already-established distribution network.

It does face competition from other retailers (both bricks and mortar as well as online), but the risks to its business are easier to see in advance and easier to protect against than say a company hoping to bring a new drug to market or a company trying to hit a home-run with a new technology it hopes consumers will adopt.

But despite the steady returns, Best Buy's stock price has been volatile (as we saw when we considered the company last year), allowing investors the ability to buy this company on the cheap. In 2008, the company was available for $18/share, a 60% discount from what it was a few months before. In 2009, the stock ranged from $25 to $45. How does the value of such a steady company change by as much as 100% in a single year?

This year appears to be shaping up in a similar way, as the stock has gone as high as $48, but has fallen by more than 25% from those levels. Much of that drop can likely be attributed to a shortfall in the latest quarter's earnings. But besides the fact that the first quarter is a nothing quarter for a retailer like Best Buy (almost 60% of the company's annual profit comes from the Christmas quarter), basing a company's value on any quarter is not a sound way to invest. This is exactly the kind of short-term thinking in which the market participates, however, which allows long-term investors to profit.

Joel Greenblatt has clearly spelled out for us the benefits of investing in high ROIC stocks when their P/E's are low. Best Buy appears to be once again (for the umpteenth time) creeping into that territory. As the price continues to fall, those who have not yet found their way into this steady performer on one of its previous price plunges may find a great price at which to do so.

Disclosure: Author has a long position in shares of BBY


editor said...

My issue with Bestbuy, is its competition. Walmart is obviously a giant and has really been stepping up its electronic focus with a revamp of the brand names it carries. Also a chunk of its business is evaporating. CDs,DVDs, Software etc. But overall yes it appears cheap enough to warrant a position.

Unknown said...


How did you go about calculating Return on Capital for this company, and what is a good way to do this for retailers, and other businesses in general?