Resolve to keep your portfolio healthy: Help us pick the worst stock for 2008.
No doubt, you savvy retail investors think I'm crazy picking Best Buy (NYSE: BBY ) as my worst stock for 2008. I can already hear you muttering in disgust ...
- The only things people really want to buy are consumer electronics.
- Best Buy has the superior combination of price, selection, and service.
- Hence, the company will continue to be an all-star.
True, all the above are key reasons why the company has thrived these past few years, virtually knocking Circuit City (NYSE: CC ) and RadioShack (NYSE: RSH ) back to the stone ages. It's almost been a perfect set of circumstances for success in what is arguably one of the toughest retail sectors.
But the situation can go both ways. As a student of retail, I have a lot of admiration for the way the company executes, but I see warning signs of trouble brewing in 2008. Consider the following:
The economy is tanking
Retail has been in a major funk for six months because consumers are worried and holding more tightly to their hard-earned dollars. Sure, Best Buy will do some business this year. But comparable-store sales growth is what drives retail earnings growth, and it can be mighty hard to come by during a recession.
Consider what a drop-off in comparable-store sales can do to a well-managed retailer. Bed Bath & Beyond (Nasdaq: BBBY ) recently reported it has grown comps 0.8% in the last quarter after posting 1.6% and 2.2% in the first and second quarter of this year, respectively. This compares to a multiyear trend averaging 4% to 5% quarterly comps. The result? The stock price droped more than 20% during 2007.
Best Buy has delivered double-digit earnings growth on a 3.3% comp sales increase for the first nine months of this fiscal year. But what would happen to earnings growth if comp sales for the company were flat in 2008? Inventory would begin to pile up, driving higher markdowns. Expense leverage would disappear. Not a pretty picture, which could take a major bite out of that price to earnings multiple of 12.
Competitors are getting smarter
Wal-Mart (NYSE: WMT ) is showing signs of finally getting its act together, particularly in the area of key-item consumer electronics like flat-panel TVs. Costco (Nasdaq: COST ) won't yield an inch in electronics market share, at any price.
Best Buy's greatest strength, total focus on electronics and entertainment, could turn into a 2008 weakness. If the huge broadline retailers decide to drive traffic during a soft sales year through loss leaders in key electronics items, a reasonable strategy, which we have seen before, the result would be price wars and lower margins. Best Buy would be caught in the middle between giants -- not an enviable position.
Buy, sell, or hold?
Don't get me wrong. Best Buy is the most effectively managed consumer electronics retailer today and is likely to hold onto that distinction for the foreseeable future. But don't get caught up in the hype. The stock is down about 15% so far in 2008, three times the drop of the Dow. Partially fueling this drop is Best Buy's recently reported comparable-store sales growth of only 1.5% in December, which doesn't bode well for 2008.
While I remain positive about the long-term prospects for Best Buy, there are warning signs that 2008 could be a difficult year. The Motley Fool CAPS Community positively gushes over the stock. I consistently trust Motley Fool readers more than Wall Street analysts, but I'm concerned that in the case of Best Buy, there seems to be universal consensus.
An overwhelming majority of both CAPS All-Stars and Wall Street analysts rate the stock to outperform. However, I prefer to pick up stocks that are unloved, rather than running with (and sometimes getting run over by) the bulls.
Why not join the Motley Fool CAPS Community and make your first pick a classic contrarian gambit, an underperform rating on Best Buy? While you're there, check out some of your other favorite stocks. It's free, and I find it both refreshing and profitable to interact with other investors who are in it purely for the love of the game.